Passed into law in late December 2022, the SECURE 2.0 Act has changed many of the rules concerning retirement plan design, required minimum distributions, and penalty-free withdrawals. Among its lesser-known provisions, SECURE 2.0 allows investors who opened a 529 college savings plan at least 15 years ago to roll over a limited amount of their unused 529 account balance into a Roth IRA without incurring a penalty. In addition, SECURE 2.0 gives more individuals with disabilities the chance to save for their future through a 529 ABLE account.

A refresher on 529 plans

A staple for almost 25 years, 529 college savings plans allow families to save for their children’s or grandchildren’s education. In addition, the Stephen Beck Jr. Achieving a Better Life Experience (ABLE) Act of 2014 created a way for individuals with qualifying disabilities to open a savings account for current and future expenses in a tax-advantaged way.

Investors are allowed to contribute large amounts of money to 529 college savings plans and ABLE plans, which provide compelling advantages over traditional savings accounts. Almost all states offer a 529 plan, with some states providing state income-tax credits, while others offer state income-tax deductions. Once the 529 plan is funded, earnings will accumulate on a tax-deferred basis, and distributions for qualified expenses are permitted tax-free. In many ways, the rules for 529 plans mirror those for Roth IRAs.

Qualified 529 plan provisions include the following:

Distributions are made on a pro rata basis between contributions and earnings. Nonqualified distributions are subject to tax and a 10% federal penalty on the earnings portion. In addition, some states may require a recapture of deductions previously allowed and impose other penalties for nonqualified distributions.

Exceptions to the 10% penalty for nonqualified distributions include receipt of scholarships, education tax credits, military academy, death, disability, and return of excess distributions.

What happens to unused funds

The biggest risk of overinvesting in a 529 college savings plan is having leftover funds when the beneficiary finishes their education. As discussed above, nonqualified distributions are subject to tax and a penalty. While funds can be transferred to alternate beneficiaries, this is often a less-than-ideal solution. There may not be any alternate beneficiaries for single child households and postponing for future grandchildren may seem untenable.

Beginning in 2024, SECURE 2.0 allows 529 owners to transfer unused funds to a Roth IRA in the beneficiary’s name. Here is an example of how this could work:

Sam and Samantha opened a 529 plan when their daughter Kim was born. Over the years, they contributed $50,000 into the plan, which has grown in value by an additional $40,000. Kim has used $55,000 of the 529 plan for her bachelor’s degree. This leaves $35,000 in unused funds, which Sam and Samantha can roll over into a Roth IRA for Kim.

Kim needs to have earned income in order to contribute to an IRA. Assuming the annual IRA contribution limit is $6,500 and Kim has at least that much earned income, her parents could transfer $6,500 from the 529 to her Roth IRA each year until the 529 account is empty or lifetime limit reached.

To ensure the rollover provision is not misused, Congress has instituted several limits and restrictions. These include:

• To be eligible, the 529 plan must have been open for at least 15 years.
• Contributions to the 529 plan within five years of a rollover are ineligible.
• The annual transfer limit equals the IRA contribution limit for the beneficiary, with a lifetime maximum of $35,000 per beneficiary.

Another important caveat about this SECURE 2.0 change is that it cannot be used to circumvent existing Roth IRA contribution limits. The sole purpose is to enable 529 plan account holders to apply leftover funds toward retirement.

Expanded eligibility for ABLE accounts

In addition to providing expanded options for 529 college savings plan beneficiaries, the SECURE 2.0 Act broadened the eligibility criteria for ABLE accounts to include individuals with qualifying disabilities that started before age 46 (previously, the age threshold was 26).

ABLE accounts are a great option to consider when families are trying to save for a disabled child’s future. Used in conjunction with other tools, such as a traditional 529 plan and special-needs trust, ABLE accounts provide a way to save money for long-range needs and goals without interfering with the beneficiary’s federal and state benefits.

Among the benefits of ABLE accounts:

• Contributions grow tax-deferred and can be made with after-tax dollars.
• Money can be withdrawn tax-free to cover a broad spectrum of eligible expenses.
• ABLE account balances are not used in determining income eligibility for means-tested government assistance programs.

In 2023, the annual limit on ABLE account contributions is $17,000. This limit may be increased if the beneficiary is working and they, or their employer, are not making certain retirement plan contributions. Entitlement to government benefits such as Supplemental Security Income or Social Security Disability Insurance automatically qualifies someone to participate in an ABLE account. Others who have a disability may self-certify by obtaining a physician’s statement.

Like 529 college savings plans, ABLE programs are established by individual U.S. states, and some rules vary from one state to the next. Some programs allow anyone to hold an ABLE account, regardless of where they live.

Helping your children plan for their future

SECURE 2.0’s rollover provision from 529 plans to Roth IRAs under is a welcome change in the world of education planning. It mitigates a primary concern that parents may have about funding a 529 plan to begin with, since they will be able to kick-start a child’s retirement nest egg using leftover funds.

As conventional investment wisdom reminds us, time in the market is what matters most. Handing over a $35,000 investment inside a potentially tax-free vehicle could add up to more than $1 million over a child’s 40-year working career. Even with very tax-efficient investments, brokerage account taxes could eat away 0.5%–1% of returns each year, which, over 40 years, could amount to $200,000–$450,000.¹

In addition, SECURE 2.0 helps clear the way for more individuals with qualifying disabilities to save for their future through an ABLE account, without compromising their government-paid benefits. For more information about ABLE plans, visit:

• https://choosework.ssa.gov/blog/2017-11-20-yawa-able-accounts-what-you-should-know
• https://www.ablenrc.org/frequently-asked-questions/

Talk with your advisor

We encourage all Mercer Advisors clients to consult their advisor regarding specific provisions in the SECURE 2.0 Act that may affect their education planning, retirement planning, and other long-range financial goals.

Also, visit our SECURE 2.0 Act resources page for timely updates and guidance on the impact of this legislation.