Mo Vidwans
By Mo Vidwans
Funding for higher and post-secondary education of our children is one of the important goals for many parents, and rightfully so. The concern usually comes when we start thinking about how much to put into a 529 account. Even though ‘not having enough money in that account’ can be handled by substituting with other ways like savings accounts. If there is too much put into a 529 account, then using it properly was always a concern since there were restrictions on such accounts primarily on how the money can be used.
If we do some long-term planning and start an account for our children right at the time when they are born then the puzzling questions always are how much money to put in and for what kind of college, public or private. All of that can be mitigated and calculated but still those are projections which will be expected to come true after eighteen or so years; and that is if your child decides to go for higher studies and not follow other alternatives.
There were some options available on what to do with 529 money if the child decides to forego college, or if too much money was placed there. The worst one of course would be to just pay a penalty (10%) and withdraw the money into regular account after paying income tax. You could always transfer the funds for another child’s education like your own younger children. In fact, it does not even have to be your child. You can be the generous donor who wants to do good for the benefit of a deserving child.
Now, America’s most attractive retirement plan (ROTH) has found another avenue for boosting it. A new law lets owners of 529 college savings plans redirect unused dollars into a tax-free ROTH account. By allowing such a move, it has made ROTH, a high standard retirement strategy, even more available to a new generation of savers.
Because of a new legislation that was signed into law last December, investors can roll-up to $35,000 from a 529 into a ROTH individual retirement account starting in 2024. Such a move takes leftover or unused money originally intended for a child’s college education (or for that matter kindergarten through 12th grade) into a retirement account. This is a smart move without imposing the saver or the beneficiary with a tax bill.
As we all know by now, ROTH, with tax-free growth and withdrawal has become an engine of great savings, and a popular favorite of most savers.
As I had mentioned earlier, previously we had only a few options of recovering the 529 money if not used for what was initially intended. The new law expands options. But I am afraid the new law does put some restrictions on transfer. It stipulates that the 529 account must be in existence for at least 15 years before any of it can be rolled into a ROTH IRA. Also, contributions and growth from the previous five years cannot be shifted over. I must admit that Government’s thinking is right in this regard; the five-year limitation exists because no one should be able to put money into a 529 with full intention of transferring it into a ROTH and those things can happen only when you know that the child is not going to use the money for higher education.
There are roughly 16 million 529 accounts with a total of about $458 billion invested in them. It is estimated that roughly 10% of such accounts end up with unused money in. And as you may have guessed, all that money is a candidate for transferring to a ROTH.
Here are some other limitations these new rules have imposed. As we all know well, especially those who have investigated investing in IRAs, there are limits on how much we can invest in these accounts and even more important beyond what income levels we cannot invest in these accounts. When it all started, IRAs were meant for low- and middle-income families to give them an avenue to be able to invest for self-retirement. It was a small step at the time and was not meant for taking care of your full needs.
The new law lets savers sidestep those income and contribution limits but as you might have guessed, only for the rolled-over amounts. When it comes to putting future money into a 529 turned ROTH, savers are still subject to the income and contributions limits.
Let us face it. These laws are nice and helpful; but they are designed to give us a way out of an unexpected situation and that was very nice of Congress to think that way. Converting $35,000 of unused 529 dollars to a ROTH is not likely to get us suddenly or instantly to the wealth mountain. It is a unique opportunity for conscientious investors in 529 to correct their thinking if they find out that their planning, done years earlier, did not quite work out as intended. It just points to a strong need for planning the deposits in the 529 accounts so that we do not even arrive at this crossroad where we must make sudden decisions like transferring a 529 to a ROTH.
Let us just understand one thing about 529 accounts. They are a good investment, but the benefits are very limited. We do not get any tax benefit from the federal government and only limited benefit from the state. Many states do not give you any tax advantage (North Carolina is one of them) and even if they do, they generally limit it to around $10,000 maximum as far as the reduction of taxable income is concerned. You can only invest in what the state makes available to you as an investment vehicle, which is very restricted. Like everything else in life, many pros and cons are to be considered before any major steps are taken.
Mo Vidwans is an independent, board certified financial planner. For details visit, vidwansfinancial.com, call 734-476-0579 or write to: [email protected]
