How the Secure Act can be an Investment Strategy
The Secure Act of 2022 included changes to 529 (educational funds) accounts that in 2023-2024 (and the foreseeable future) may be used as an investment strategy for those who are maxing out their current after-tax vehicles.
Introduction:
The Secure Act of 2022 has proven to be a pivotal step for employers allowing them to better cater to their employee’s retirement goals. In this article, we highlight the updated benefits you need to know for the 529 plan under the Secure Act 2.0. The 529 plan has served as a valuable after-tax investment vehicle that one could use to save for educational related expenses. See our article How to use a MESP 529 to gift education to your loved ones for more information about 529 plans.
How does a 529 work?
On surface level, a 529 plan is similar to how a Roth IRA functions; with after-tax funds being the source of yearly contributions. The difference with a 529 plan is that distributions can only go towards educational related expenses whereas Roth IRA distributions have no such restriction. With the introduction of the Secure Act 2.0, the 529 plan will now allow for rollovers out of the plan and into a Roth IRA for an amount up to $35,000 over the course of one’s lifetime. The ability to do this rollover from a 529 plan to a Roth IRA will commence in the 2024 calendar year and allow one to avoid the 10% penalty withdrawal from a 529 distribution that does not qualify as an education expense.
Using a 529 as an investment vehicle
This newfound ability to use 529 distributions as Roth IRA contributions provides another opportunity to consider when approaching financial planning our team will be considering for the 2023 tax year and beyond. Overfunding a 529 plan for a beneficiary in the present may create an opportunity in the future to contribute to your beneficiaries Roth IRA from their 529 plan.
Limitations:
One should still be aware of the limitations of these distributions from a 529 Plan. Firstly, any rollover amount from the 529 to a Roth IRA will be subject to the annual contribution limit of a Roth IRA. The max Roth IRA contribution limit applies to beneficiary of the 529 plan. If the fully allowable amount is rolled over, the beneficiary will not be eligible to contribute any more funds to your Roth IRA in that Tax Year since the rollover amount counts toward the contribution limit. Also, if the beneficiary is phased out of Roth IRA contributions because their earnings are too high, they not be able to roll the 529 plan over to a Roth IRA.
Another limitation is that the 529 plan must have been open for 15 years prior to the rollover to a Roth IRA. This limits the ability to use a 529 plan as a backdoor Roth IRA at initiation or close to initiation of the 529 plan.
Give us a call, we can help
When considering whether or not a 529 plan is right for you and your beneficiaries circumstances knowing how the rules change under the Secure Act 2.0 may be pivotal in deciding which type of account to use for education related expenses.
At Kroon & Mitchell we believe in an integrated approach to tax and investment. Any investment strategy has tax implications. We customize our approach based on your needs and financial goals. Contact us for a free consultation.
