529s for the Whole Family Instead of Just the Kids

[YttriumNitrate]

New laws allow each beneficiary of a 529 plan to rollover up to $35k in 529 funds into their Roth IRA so long as the  529 plan has been open for at least 15 years, the funds being rolled over were not added in the last five, and the beneficiary has not been changed (probably). [link]

Currently, I have 529 plans set up for my two children who are in first grade and preschool, and have been funding them at $5k/yr to take advantage of Indiana’s generous 20% tax credit. However, with these changes in the law, I am considering pausing the funding of my kids’ 529 plans and instead directing the annual contributions to 529 plans set up for my spouse and myself. Funding of the kids' 529 plans would resume when the parental 529 plans have about $12,000 each (figuring in 15 years that might be worth $35k).

My thinking is that if the kids need more money for their education than is in their individual 529 plans, there will be no penalty to transfer funds from the parental 529 plans. Alternatively, if there is money left over in the 529 plans, it will probably be advantageous to be able to roll the money into my own Roth IRA rather than just the kids IRAs.

Of course the laws can change significantly in the next 15 years, but I was wondering if anybody sees any obvious flaws in this plan.

[Midwest_Handlebar]

I don't think it's a bad idea, but not sure if the juice is worth the squeeze:

"Indiana taxpayers may receive a state income tax credit equal to 20% of their contributions to a CollegeChoice 529 account, up to $1,000 per year ($500 for married filing separately) through December 31, 2022. Contributions by Indiana taxpayers made on or after January 1, 2023, will qualify for the 20% tax credit, with a new maximum of up to $1,500 ($750 for married filing separately)"

So you would put $7,500 in a year ($7,500 X 20% = $1,500) for 3 years? Total $4,500 tax savings? Not bad, but how do the rest of your investments look. Are you maxing out all other tax advantaged accounts (roth, 401k, hsa)? Do you have money in non-retirement accounts? Decent Cash Position? Interested in investing in real estate?

Personally, I would keep investing in the kids' 529 accounts (still getting the tax benefit outlined above) until those buckets are full and invest in other accounts/asset classes with any surplus.

[secondcor521]

The 529->Roth rollover requires the beneficiary to have earned income to qualify (like for a normal Roth contribution).

In 15 years, you and/or your wife might be retired, and may not have earned income to qualify for the 529->Roth rollover.

An escape hatch, though, would be to use the new law as intended, roll your 529s into your kids' 529s, and then do some 529->Roth rollovers for your kids.  (It's not clear to me whether rollovers count as contributions, though, so you might have to wait a further 5 years if you do this escape hatch, because there is another clause in the law requiring that rollover money can only come from contributions which are five years or older.)

[YttriumNitrate]

The 529->Roth rollover requires the beneficiary to have earned income to qualify (like for a normal Roth contribution).
In 15 years, you and/or your wife might be retired, and may not have earned income to qualify for the 529->Roth rollover.

The point about earned income is a good one. I suppose if I don't have a modest earned income when the kids start university I would be more likely to drawing/gifting from the parental 529s earlier to pay for their education.

[YttriumNitrate]

So you would put $7,500 in a year ($7,500 X 20% = $1,500) for 3 years? Total $4,500 tax savings? Not bad, but how do the rest of your investments look. Are you maxing out all other tax advantaged accounts (roth, 401k, hsa)? Do you have money in non-retirement accounts? Decent Cash Position? Interested in investing in real estate?

Just to keep things simple, let's assume that a fixed amount of money will be going into 529 plans and the only variable is how the money is divided among the beneficiaries.

[mistymoney]

seems a bit scammy....I was think we were going to talk about funding 529s for taking college courses for FIRE enrichment activities....

[seattlecyclone]

I guess the biggest risk I see would be your state amending their laws in the next 15 years to get rid of this loophole. Many states already have rules clawing back the state tax benefits if you later make a disqualified withdrawal of the 529 money; seems like this would logically go together with that. They want to give you a tax benefit to save for education, not to contribute to your Roth IRA.

[Midwest_Handlebar]

So you would put $7,500 in a year ($7,500 X 20% = $1,500) for 3 years? Total $4,500 tax savings? Not bad, but how do the rest of your investments look. Are you maxing out all other tax advantaged accounts (roth, 401k, hsa)? Do you have money in non-retirement accounts? Decent Cash Position? Interested in investing in real estate?

Just to keep things simple, let's assume that a fixed amount of money will be going into 529 plans and the only variable is how the money is divided among the beneficiaries.

If that's the case, I don't get the upside? Just fund your kids 529's and stop when they have enough. If you want to save on taxes buy real estate.

[YttriumNitrate]

I guess the biggest risk I see would be your state amending their laws in the next 15 years to get rid of this loophole. Many states already have rules clawing back the state tax benefits if you later make a disqualified withdrawal of the 529 money; seems like this would logically go together with that. They want to give you a tax benefit to save for education, not to contribute to your Roth IRA.

Indeed, a change in the laws could definitely be a downside. However, given the long time periods involved for this to work, the relatively small benefit, and the obscurity of the rules I'm not very concerned about there being a public outcry to change the rules due to some evil 1%ers are benefiting from them.

[YttriumNitrate]

So you would put $7,500 in a year ($7,500 X 20% = $1,500) for 3 years? Total $4,500 tax savings? Not bad, but how do the rest of your investments look. Are you maxing out all other tax advantaged accounts (roth, 401k, hsa)? Do you have money in non-retirement accounts? Decent Cash Position? Interested in investing in real estate?

Just to keep things simple, let's assume that a fixed amount of money will be going into 529 plans and the only variable is how the money is divided among the beneficiaries.

If that's the case, I don't get the upside? Just fund your kids 529's and stop when they have enough. If you want to save on taxes buy real estate.

The main upside would be that if there is money left over (e.g., kids get scholarships, go to less expensive schools, or don't go to college) the money can be rolled into kids' IRAs, the parents IRAs, or both the kids' and parents' IRAs. If it's only the kids' 529 plans that get funded then only their IRAs can receive the rollover.