An important provision of the SECURE 2.0 Act allows the transfer of funds from a 529 account to a Roth IRA. Financial media is excited for this change because it solves a common problem of what to do with funds leftover in a 529. But there are some details we’d like clarified before we recommend this maneuver under all but the most plain-vanilla circumstances.
First, the law states a designated beneficiary must have maintained the 529 for at least 15 years. Does that mean the same individual must have been the beneficiary for all 15 years? Or does it simply mean that the 529 must be at least 15 years old? Congress wasn’t clear, and the IRS hasn’t offered any clarification.
Next, this might come with a tax bill in certain states. Eight states plan to charge state tax on some or all of a conversion. An additional seven states still haven’t decided what to do. California is notable in that it charges state income tax plus a 2.5% penalty on investment earnings from a 529-to-Roth conversion.
On the whole, the 529-to-Roth conversion could be a useful planning tool for a lot of reasons. It could be incredibly useful for those who earn too much to contribute to a Roth IRA, since income limits don’t apply to these conversions. But we need more clarification of the finer points before we can make a clear recommendation.
Fortunately, the clock isn’t ticking. This law isn’t a one-time window, and it doesn’t have a sunset provision. For now, funds in a 529 should probably stay in a 529, invested in the stock market, while we await clarification needed to make a recommendation that will offer the greatest benefit.
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