The problem with 529 plans has existed since the commencement of the program. They have always carried an element of risk. You took a chance that your kid might enroll in the university, and the odds of your kid getting a scholarship were a bet you were willing to take. You took a chance by making contributions to the 529 plan.
Why the 529 plan was a risk?
A 529 plan is an irrevocable investment vehicle for saving for future education costs, and that money can only be used for authorized school costs. It’s important to remember that not all tuition costs qualify.
SECURE 2.0 has changed the risk of a 529 plan, allowing the monies deposited into the plan to be converted into an investment vehicle for your child. In 2024, unused funds in a 529 plan will be able to be converted to Roth IRAs for the beneficiary child. Historically, many people have been hesitant to use the 529 plan, but this modification should ease any unease regarding the use of this plan.
Suppose a child’s grandparents invest money on behalf of a grandchild, but the funds are not used for higher education pursuits. In that case, they may find comfort in knowing those funds can be turned into an account that will benefit the grandchild later in life (in retirement) or even be used to buy a home for the first time.
But hold on! Still more! You may make your middle-class teenager a millionaire by transferring their 529 money to a Roth IRA.
However, there are limitations to which you must adhere. According to Million Dollar Round Table alum and principal of FSM Wealth in Nashville, Illinois, Brian Heckert, starting in 2024, holders of 529 plans will be able to roll their balance into Roth IRAs tax and penalty-free. The maximum amount you may move into a Roth IRA is $35,000. Rollover limits apply; the maximum yearly amount contribution to a Roth IRA is $6,500 in 2024. The account owner’s Roth IRA is ineligible to receive the transfer; the beneficiary’s Roth IRA is the sole eligible destination.
For this reason, if a parent has a 529 plan and has designated their kid as the beneficiary, the rollover must be made into the Child’s IRA and not the parent’s. Problematically, account holders cannot roll over contributions or earnings on contributions made within the past five years. The 529 plan must also be at least 15 years old. While this might add some complexity to the procedure, making it less straightforward, it’s not too difficult. Even if any of the specifics of the procedure alter in the future, the steps themselves will still be the same.
Think about the $35,000 limit for the rest of your life. This maximum amount may be moved from a 529 plan into a Roth IRA for a kid. To that end, your primary objective should be to save up enough money in a 529 plan to generate a surplus of $35,000. Please keep in mind that this is your intended outcome.
Remember that there is a limit on how much you may put in each year. Even if it’s $6,500, it is expected that Congress will raise that figure eventually. For the sake of this example, let’s pretend that the yearly contribution cap is fixed at $6,500. To put this in perspective, if the lifetime maximum is $35,000, you will hit that threshold in the sixth year after you begin the conversion process. (In the sixth year, you’ll only be able to convert $2,50.)
Because the $ 35,000 lifetime cap will take six years to reach, you don’t have to reach it the year you begin the conversion. So, what’s your dollar goal when you start the conversion? Using the current 5-year Treasury rate of 3.65%, you’ll need $31,250 to begin your conversion year.
According to SECURE 2.0, you’ll have to wait 15 years before switching. To rephrase, you have until he or she is 18 years old to have $31,250 in excess funds in a 529 plan. Here are two straightforward approaches to taking care of the issue: 1) Put away a large sum of money the first year, and 2) keep putting away the same amount each year after that. The lump sum approach requires an initial investment of $9,850 if the expected rate of return is 8% per year. For a regular annual contribution over 15 years, setting aside $1,030 each year is recommended. At the end of 15 years, you’ll have $31,250.
The age of the child when the 529 plan was formed will determine when the money in the account can be converted to a Child IRA. Morningstar reports that the typical age at which parents open a 529 plan is when their child turns seven. Because of this, according to Morningstar, the kid would have lost $30,000 had the 529 plan been established at the time of birth (assuming the parents saved $50,000 throughout the 529 plan’s lifetime). Initiating a 529 plan for a kid at age 7 will delay the commencement of the conversion procedure until the youngster is 22 years old. Conversion could start at 16 years old if the 529 plan was set up when the child was born. How much more do we spend on a 7-year-old than on a brand-new baby? If the 7-year-old continues to earn an average annual rate of return of 8% (instead of the historical average of 11%), their child IRA will be worth $1,3,000,000 when he or she is 70 years old and has reached retirement. However, by the time the infant (the account set up at birth) is 70 years old, their child IRA will be worth $2.1 million. Almost $800,000 is the difference.
Considering these are rough estimates, the numbers may vary slightly, but the overall picture will remain the same.
The main point is as follows: You should immediately open a 529 plan for your kid if you haven’t already.
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