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  • Writer's pictureJosh Dandurand

Supporting the Initial Launch: 529 to Roth IRA Rollover Opportunity

Updated: Feb 21

As a father of four, I think about my children’s future constantly. Thoughts range from simple things like how well they will drive their first car, to more complex issues such as whether they’ll make personal and professional decisions that allow them to live a fulfilled life. If you have children of your own, I’m sure you can relate.

I haven’t quite come to terms with a solution to ensure my kids are guaranteed a path to fulfillment and happiness, but one way I have found that I can positively influence their chances of success is to prepare for their “initial launch”, a term I’ve borrowed from Kathy Patton, leader of the Walden Roots process.

We define the initial launch as the point in time at which we send our children off to their next step, whatever that may be. For some this will mean post-secondary education, for others it will mean pursuing a trade or entrepreneurial endeavors. Whatever the next step is, one thing is for sure – there will be a next step, and we all want to be able to support our kids in whatever that is.

In the past, this conversation has almost been exclusively focused on preparing for college, but in recent years, with the increasing cost of college and strong wages in many trades, the conversation has become more open ended, with many having a desire for more flexibility with the financial resources earmarked for supporting the initial launch.

There are a few options to financially prepare for the initial launch, one of which is a 529 educational savings account. A 529 account can be a great tax efficient savings vehicle for those with a long time horizon, as all earnings grow tax free and all withdraws used for qualified education expenses come out tax free. It’s basically a Roth IRA for education expenses.

Here are a few things that you should know about 529’s:

- Contributions to a 529 plan are not tax deductible at the federal level.

- Some states offer an income tax deduction for 529 contributions up to a certain dollar amount per contributor, per beneficiary, ranging from $0 - $20,000 annually depending on the state and contributors filing status. The Ohio 529 plan allows for $4,000 to be deducted per contributor, per beneficiary.

- Earnings grow tax free.

- Contributions and earnings withdrawn for qualified educational expenses are tax free.

- Qualified educational expenses include tuition, housing, meals, books, supplies, and specific equipment, including digital devices, with certain conditions based on the students’ credit load.

- A maximum of $10,000 can be used to pay student loan debt.

- Up to $10,000 can be used annually to cover K-12 tuition, but some states might have tax implications.

- 529 funds can be used for postgraduate programs which includes law school, medical school and business school for example.

- Transferring 529 funds to family members is tax-free.

- Upon the owner's death, the 529 account can be bequeathed, continuing indefinitely without mandatory withdrawals.

Sounds pretty good, right?

Well, one of the potential downsides of the 529 has been the limited number of options for funds not used or needed for educational expenses. As mentioned above, there are options to transfer unused funds to other family members, and there are provisions to ensure you and your child are not penalized for getting scholarships, but in general, if you have funds left in the account after your children complete their formal education, you are kind of stuck.

However, that changed on December 29, 2022, when the latest SECURE 2.0 legislation was signed into law, which now allows for transfers from a 529 account to a beneficiary’s Roth IRA, within specified limits. This new provision might be a beneficial avenue for those unused funds.

Here are a few things you should know about the 529-to-Roth Rollover Provision:

- It becomes effective beginning in 2024.

- The 529 account must be at least 15 years old.

- The total lifetime transfer limit is $35,000 per beneficiary.

- The Roth IRA must be in the beneficiary of the 529’s name (your child).

- Funds contributed (and their earnings) within the last five years can't be rolled over.

- The yearly rollover is limited to the year's IRA contribution limit minus any other IRA contributions.

- Rollovers must be direct, from plan to plan, without cashing out the 529 account.

- Beneficiaries with income exceeding the IRS income limit for Roth contributions can still contribute to a Roth IRA using the rollover.

- Only those with earned income can complete the rollover, with the amount being the lesser of earned income or the IRA limit.

Say you open a 529 account for your child when they turn 1 and contribute $1,200 each year until they reach age 18. Using a 7% average annual rate of return, the account value should be somewhere around $45,000 at 18. Let’s look at a few scenarios of how the funds might be used:

1. The child goes to college and 100% of the funds (contributions and earnings) are withdrawn tax-free to cover qualified education expenses.

2. The child moves right into the work force and begins to earn an income. They open a Roth IRA and each year make the maximum Roth IRA rollover contribution (currently $6,500). After about 6 years, at age 24, they have rolled over $35,000 into the Roth IRA. You, the account owner, change the beneficiary of their 529 to their younger sibling for the remaining $10,000 in the account. The Roth funds are invested and earn 7% annually until your child reaches age 65, at which point the account value will be somewhere around $600,000.

3. The child goes to a 2-year trade school and uses $20,000 to cover education costs, leaving a balance of $25,000 in the 529. Upon graduation they open a Roth IRA and rollover the remaining funds over a four-year period, leaving them with a $20,000 Roth IRA. A few years later they decide they’d like to buy a house, so they use $10,000 from the Roth as a down payment (taxed at their individual income tax bracket but not subject to penalty) and leave the other $10,000 invested indefinitely, earning 7% annually. They live to 100 and leave behind a Roth IRA worth $1.6M to their estate.

These examples are clearly hypothetical, but hopefully help illustrate a few of the options this new provision bring into play.

So, while 529 Education Savings Accounts aren’t a perfect fit for everyone, and this new provision might not be the end all be all, it certainly provides a more flexible approach to supporting the initial launch. Roth IRA’s are an incredible wealth building tool, and the sooner the account can be funded the more leverage you’ll get from the magic of compounding interest.

A parent’s role in a child’s initial launch begins at birth. Every day we’re doing our best to make sure they are properly equipped to enter the real world. The financial support we offer is just one way we can increase the odds of a successful launch. So, however you choose to support your child’s initial launch, we’re here to help. If you have specific questions or would like to explore additional strategies, I invite you to schedule an introductory call HERE.

If you found these thoughts to be interesting, helpful or entertaining, please feel free to share with a friend.

Dandurand Financial Partners, LLC d.b.a Walden Financial is a registered investment advisor offering advisory services in the State of Ohio and in other jurisdictions where exempt. Registration does not imply a certain level of skill or training. The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal any performance noted on this site. The information on this site is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Dandurand Financial Partners, LLC d.b.a Walden Financial disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose. Walden Financial does not warrant that the information on this site will be free from error. Your use of the information is at your sole risk. Under no circumstances shall Walden Financial be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided on this site, even if Walden Financial or a Walden Financial authorized representative has been advised of the possibility of such damages. Information contained on this site should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.

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