Suze School: 529 Plans and Roths - What You Can and Can't Do - Podcast Episode

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Today’s Suze School is an answer to a question Allison asked on the last Ask Suze and KT Anything episode (479), about converting unused money from a 529 plan into a Roth retirement account.

Podcast Transcript:

00:00:02

Music: Music (in)

00:00:28

Suze: June 25th, 2023. Welcome everybody to the Women and Money podcast as well as everybody smart enough to listen. Suze School today and Suze school today is going to have to do with the first question that KT asked me on Thursday, which was from a woman by the name of Alison.

00:00:55

Suze: And she was asking me about this new law that passed that allows you to take $35,000 from a 529  plan that you have not used and put it into a Roth Ira. And she was asking me questions about it

00:01:13

Suze: and this is a very, very complicated procedure that all of you should know about, by the way. So, on that podcast, I said no, no, this is a Suze school. So I am going to do the Suze School on that today. So get out your little Suze notebooks because this really, especially if you have children, you have grandchildren.

00:01:37

Suze: This is something that you should absolutely know about. But before I go into that, I know, I know, I know. I know that a little bit ago that the Feds didn't raise the interest rate, the fed funds rate for the first time in over 10 raises by the feds. They did say however, that they expect to raise it twice again, probably a quarter of a percent.

00:02:06

Suze: But why haven't I said anything about it because there's not a lot to say about it. Everybody, inflation is definitely starting to come down. Is it coming down as fast as they want? No,

00:02:22

Suze: but we've talked about that. That's one of the reasons I didn't want you to buy new Series I Bonds and that there would be probably better things to do with your money. What it does mean however, is that the interest rates that you're going to pay on mortgages most likely are going to stay where they are, the interest rates that you are going to be paying on credit cards will probably stay where they are.

00:02:50

Suze: The interest rates on home equity lines of credit will probably stay exactly where they are. But interest rates on treasuries and CDs and things like that will also probably stay where they are for whatever reason, against all odds. This is a resilient economy.

00:03:11

Suze: People are still spending, I don't actually understand how or why we see real estate not going down but also not really going up either.

00:03:24

Suze: But it's still solid in many different ways. And what's keeping people from buying are the interest rates for the new mortgages that people are getting. So real estate hasn't been damaged. The stock market has had a fabulous return whether it stays there or not, no way for anybody to know. But I do know one thing when it comes to investing

00:03:50

Suze: that artificial intelligence, artificial intelligence more than any other investment that we have heard of lately, whether it's crypto Bitcoin, whatever those things are,

00:04:06

Suze: you know,

00:04:07

Suze: artificial intelligence is going to absolutely change our way of life, our way of doing anything and everything.

00:04:19

Suze: And I think more money will be made in artificial intelligence, in the stocks that invest and create artificial intelligence than almost any other area. So I think that in the years to come,

00:04:37

Suze: it should be lucrative for us. We've also learned that it's really, really important to continue to dollar cost average into the stock market,

00:04:50

Suze: something that we've been doing for a long time now. So let's now switch to Suze School. So like I said, take out your notebooks because this is really a topic that everybody should know about and how they worked. But to begin with, let's talk about what is a 529 plan.

00:05:18

Suze: So a 529 plan is simply an educational savings plan that's designed to help families save for future educational expenses. Just that simple everybody. And so the name 529 comes from the section 529 of the internal revenue code, you know, which governs these plans. I always tell you that because it seems like you want to know.

00:05:44

Suze: Now every single state or state agency or whatever has a 529 plan. There are two main types of 529 plans that you need to know about. One is the prepaid tuition plan and the second one is the college savings plan. Are you writing this down

00:06:11

Suze: Now, prepaid tuition plans will allow you to prepay

00:06:17

Suze: the future tuition costs at today's prices. I love prepaid plans because it takes all the guess work and investment, work out of it. So it's a good option if you are pretty certain that your beneficiary is going to intend an in state public college or university,

00:06:42

Suze: that's when you want to look into prepaid plans. However, on the other hand,

00:06:51

Suze: college savings plans are really just investment accounts that offer you various investment options so that you can grow your contributions over time. Now, these plans I have to tell you are more flexible and can be used for a much larger range of educational expenses such as tuition fees, books supplies, and even room and board.

00:07:20

Suze: It's not how a prepaid plan works. So what you need to really understand, however, is one of the significant advantages of putting money into a 529 plan

00:07:38

Suze: is the potential for the tax benefits that this plan offers you and the beneficiary of this plan, which is usually your child or grandchild or the person that's going to be going to a university.

00:07:55

Suze: So even though you cannot not deduct the money that you put into a 529 plan on your federal tax return

00:08:07

Suze: the earnings in the account though are going to grow tax free. Did you hear me? That means you won't have to pay federal taxes on the investment gains as long as the funds are used for qualified educational expenses.

00:08:28

Suze: Now, qualified educational expenses typically include tuition fees, oh, books supplies and equipment for enrollment or attendance and an eligible educational institution. It's essential that you note that if you withdraw funds. However, for non qualified expenses, which is what Alison wants to do,

00:08:57

Suze: you'll likely face taxes and penalties on the earnings portion of the money that you put in another advantage. Just so you know, of 529 plans is the high contribution limits that you can put in in. It may vary state by state. They're really high often reaching like hundreds of thousands of dollars per beneficiary.

00:09:25

Suze: So this provides you really with an opportunity for substantial savings to cover educational costs. Now, I just have to say one or two more things now about 529 plans since you know about them, or you're learning about them. All right. Now, you just heard me say that 529 plans do not offer a federal tax write off.

00:09:54

Suze: However, there are over 30 states that currently offer a state income tax deduction or tax credit. So you need to check that out. Usually it's about $5000 per person or maybe $10,000 for a married couple.

00:10:15

Suze: So just check that out. But you need to know that in most cases that you have to contribute to your home state 529 plan to qualify for a state income tax benefit.

00:10:31

Suze: But there are approximately nine states that will offer a state income tax benefit regardless of what 529 plan you contribute to. So just know that now another benefit of a 529 plan is flexibility.

00:10:55

Suze: You need to know this if the beneficiary decides not to pursue a higher education or they receive scholarships. So in such a case, you can change the beneficiary to another family member such as a sibling or a first cousin without facing any taxes or penalties. Got that?

00:11:24

Suze: Let' address one of your biggest concerns. However, about 529 plans, the impact on financial aid eligibility when applying for a need based financial aid such as grants or scholarships, the value of a 529 plan is generally considered an asset of the account owner, usually the parent.

00:11:53

Suze: So this means to you, listen to me because you're all getting this wrong when you're writing me, this means it has a smaller impact on eligibility compared to accounts owned by the student, such as accounts to a unified gift to minors act account that will hurt your child more for financial aid than money in a 529 plan.

00:12:23

Suze: All right, you've got to know that and the reason is you also have to know is that in the year that you take money out of a 529 plan and it's used for educational purposes. It's not counted as income in the subsequent years for financial aid calculations. So there are all kinds of ways that you can use money in a 529

00:12:53

Suze: and really qualify for financial aid. But you have the option of many states, all of that, but that's how they work.

00:13:04

Suze: However, what you need to know is that your kid doesn't go to school, you don't have any other beneficiaries and now you have all this money in a 529 plan.

00:13:19

Suze: Anything that you earned above the money that you put in. So your earnings, if you go to take that money out, you're going to have a 10% penalty and pay ordinary income taxes on that money.

00:13:34

Suze: That's how it works.

00:13:38

Suze: Now, here's where the lesson really begins

00:13:44

Suze: Recently, there was a bill passed Secure Act 2.0 that's starting in 2024. So not till then if you have a 529 plan

00:14:00

Suze: and you have a balance in there that you can't use transfer or anything, how you can transfer that money to a Roth Ira.

00:14:13

Suze: And recently some financial publications just did massive emails saying just know if you have a 529 plan and there's money in it, we can then transfer $35,000 to a Roth Ira. Learn about it. And that is why last Thursday Alison wrote in because she has money in three 529 plans

00:14:43

Suze: that she is not going to have to use for her kids' college education because her ex spouse is paying for them. So she wants to know can she transfer that balance for each one of those accounts to her Roth Ira? Now, one would think that you might be able to, but it doesn't work that way on any level.

00:15:12

Suze: The first thing that you need to know is that this bill does allow the custodian to convert it, but it can only be converted

00:15:25

Suze: to the beneficiarie's Roth Ira. It cannot be converted to the custodians, Roth Ira. It has to be converted to the beneficiaries. Roth Ira. Note that first, next, none of this takes effect by the way till 2024.

00:15:52

Suze: Here's what's important for you to understand

00:15:57

Suze: the 529 plan

00:16:00

Suze: must have been maintained by you for 15 years or longer.

00:16:09

Suze: It's not like you started a 529 plan three years ago and now the kid is not going to college and now you want to convert that money to the kids. Roth Ira. Nope,

00:16:22

Suze: it has to have been maintained for 15 years or longer.

00:16:30

Suze: Next. You have to know that any contribution that you make to the 529 plan within the last five years and the earnings on those contributions are ineligible to be moved to a Roth Ira.

00:16:52

Suze: So don't go out there thinking, oh, I'm going to fund a 529 plan and then I'm gonna be able to move it to a Roth Ira for my kid. No, it doesn't exactly work that way.

00:17:07

Suze: Any contribution that you made to a 529 plan within the last five years

00:17:17

Suze: before you want to change it to a Roth Ira are ineligible and that includes its earnings, write it down because I know you're gonna forget it

00:17:30

Suze: next. What you have to understand is in the very same way

00:17:37

Suze: that I would tell all of you if you have a 401k plan, that's a Roth. Please make sure that you open up a Roth Ira even if you just fund it with $1

00:17:50

Suze: so that you could convert the Roth 401k to a Roth Ira and not have to worry about the five year rule. If you opened up the Roth Ira more than five years ago, the same is true with the Roth Ira for the 529 plan. So what all of you should be doing

00:18:17

Suze: is opening up a Roth Ira and just so you have it in the beneficiary's name. If you're going to ever do this, as long as the beneficiary has earned income. Remember, you only need to open it up even if it's worth $5.

00:18:41

Suze: Make sense. Maybe. Yes, maybe, no. But that's something you should do.

00:18:47

Suze: The next thing you need to know, you have to have a beneficiary that is actually working in the exact same way again that you can only contribute money to a Roth Ira or a traditional Ira is you have to do it with earned income.

00:19:06

Suze: And the maximum that you can put in under 50 for instance, is $6500 this year or whatever you earned, whatever is less.

00:19:20

Suze: So, the same is essentially true for a 529 . If you're going to transfer it to a Roth Ira, the beneficiary has to have earnings otherwise it can't be transferred. All right,

00:19:42

Suze: the maximum lifetime transfer to the beneficiary is $35,000.

00:19:52

Suze: So you cannot put $35,000 in all in one lump sum.

00:19:59

Suze: What has to happen is the maximum that you can put in

00:20:05

Suze: to a Roth plan from a 529

00:20:10

Suze: is limited to the amount of the contribution limit for Roth Iras that year.

00:20:18

Suze: So if the Roth Ira limit is only $6500 that's the maximum that you can put in from the 529 into the Roth. Now, if the beneficiary has been putting money into a Roth or into a traditional in their own name,

00:20:41

Suze: then whatever they have put in is subtracted from what you are allowed to put in to the Roth Ira from the 529 .

00:20:55

Suze: Now, one great thing is Roth Ira income limits do not apply. So there is no adjusted gross income here. But you understand, this is far more complicated than most of you have any idea.

00:21:11

Suze: So, don't go thinking that you're just gonna be able to transfer $35,000 in one lump sum and a 529 plan to your kids, Roth Ira because that money was left in their 529 plan. They didn't use it up. I don't think so. So remember the beneficiary must have compensation.

00:21:36

Suze: The 529 plan must have been maintained for 15 years or longer

00:21:43

Suze: any contribution to the 529 plan within the last five years and the earnings on those contributions are ineligible to be moved to a Roth Ira.

00:21:55

Suze: The Ira is subject to the contribution limit for whatever it is that year of the Roth, less any regular traditional Ira or Roth Ira contributions annually. The maximum lifetime transfer to a beneficiary is $35,000. The money must be moved directly from the 529 plan to the Roth Ira.

00:22:23

Suze: The Roth Ira receiving the funds must be in the name of the beneficiary of the 529 plan

00:22:31

Suze: and 529 contributions and earnings go into the Roth Ira in like kind. What that means is if you have investments in your 529 plan,

00:22:46

Suze: those exact same investments will transfer over to the Roth Ira. That's how it works. Aren't you glad Alison asked that question? But it's really important for you to know all of this because I would bet you that nine out of 10 of the people out there don't have a clue to anything that I just told you about.

00:23:16

Suze: So write it down, keep the number of this podcast because undoubtedly there is going to come a time when you have money left over in a 529 plan and somebody is going to tell you, oh, just put it in a Roth Ira for your kid and you're gonna go, ok.

00:23:38

Suze: Unh unh, come back to this podcast or to your Suze notebook and then you'll know exactly what you can and can not do. All right, that brings us to the end of this Suze School. We are almost halfway through everybody of Robert gallivanting around the United States to see his favorite band. And so he's having a fabulous time,

00:24:07

Suze: but it really puts a time crunch on all of these podcasts. But kudos to Robert, because he does these on the road with his little laptop. So he wants you all to have new podcasts. He didn't want to just do Ask Suze Anything with KT the whole time. He didn't want to run best of. So because of extraordinary effort by Robert,

00:24:37

Suze: we get to hear these brand new podcasts and Travis, my nephew, who I love so much. It is your birthday day. So happy, happy birthday.

00:24:56

Suze: So never forget everybody today. Wherever I go, I will create a more peaceful, joyful and loving world. And I promise you, if you say that every single day and do it,

00:25:11

Suze: you will be unstoppable.

00:25:21

Music: Music (out)

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