New 529 to Roth pipeline / ladder?

[ChpBstrd]

https://www.schwab.com/learn/story/529-to-roth-ira-rollovers-what-to-know

The gist is a new law allows you to roll up to $35k in 529 money into a Roth without triggering taxes or penalties...

• IF you'd had the account for 15 years and
• excluding any contributions/earnings from the prior 5 years and
• only up to the limit for contributions.

The main use case would be for someone planning a retirement to put $35k into a 529, let it sit some years as required, and then roll the money into their Roth during retirement - without triggering any taxes, fees, or increase in earnings. This could occur at the same time an early retiree is withdrawing from their Roth early in FIRE.

A secondary use case would be for parents to overfund their kids' educations with tax-deductible contributions, setting them up with a nice Roth sometime in their 20s or 30s that will be tax-free money to use for a house, nest egg, etc.

The article says there remains a lot of IRS rule making yet to occur, but it might make sense for us to all open 529s and fund them with a few bucks so the 15y clock can start ticking.

[EvenSteven]

Before this became law I remember some other limitations, such as:

"The beneficiary must have earned income, and the amount that can be rolled over is the lesser of earned income or the IRA contribution limit. Therefore, if the beneficiary is not working, no rollover is available because there is no earned income."

This would nix your main use case here.

[ChpBstrd]

Before this became law I remember some other limitations, such as:

"The beneficiary must have earned income, and the amount that can be rolled over is the lesser of earned income or the IRA contribution limit. Therefore, if the beneficiary is not working, no rollover is available because there is no earned income."

This would nix your main use case here.

The main use case was to put $ into your own 529 while working and then move it to your own Roth. I left out the while working part and see how that could cause confusion.

With the secondary use case, presumably the kids can be earning $6,500 per year by the time they roll over their 529 leftovers into their Roths.

[YttriumNitrate]

Before this became law I remember some other limitations, such as:
"The beneficiary must have earned income, and the amount that can be rolled over is the lesser of earned income or the IRA contribution limit. Therefore, if the beneficiary is not working, no rollover is available because there is no earned income."
This would nix your main use case here.

Your definition of retirement is not the same as Mr. Money Mustache's definition.

https://web.archive.org/web/20130218001502/https://www.mrmoneymustache.com/2013/02/13/mr-money-mustache-vs-the-internet-retirement-police/

[EvenSteven]

Before this became law I remember some other limitations, such as:

"The beneficiary must have earned income, and the amount that can be rolled over is the lesser of earned income or the IRA contribution limit. Therefore, if the beneficiary is not working, no rollover is available because there is no earned income."

This would nix your main use case here.

The main use case was to put $ into your own 529 while working and then move it to your own Roth. I left out the while working part and see how that could cause confusion.

With the secondary use case, presumably the kids can be earning $6,500 per year by the time they roll over their 529 leftovers into their Roths.

As an escape hatch for an over funded 529, I agree it's very useful. I think the usefulness of the use case where you intentionally over fund in order to later fund a Roth is more dubious.

You won't be able to get any more money into a Roth using this method, so the use would be to over fund a 529 15 years in advance of where you are planning to be retired but still have at least 6500 earned income. The max benefit, if you time things perfectly, you would get is your marginal tax rate in retirement on about 20k of capital gains, right? Situational I suppose, but it seems like a fair amount of risk you would need to balance against however much that benefit is worth to you.

Your definition of retirement is not the same as Mr. Money Mustache's definition.

https://web.archive.org/web/20130218001502/https://www.mrmoneymustache.com/2013/02/13/mr-money-mustache-vs-the-internet-retirement-police/

Im not trying to internet retirement police you, but pointing out that if you are using this method you need to plan 15 years in advance that you will have at least 6.5k in earned income, be retired, and be above the zero percent capital gains rate in order to get any gain from this method.

[secondcor521]

The main use case was to put $ into your own 529 while working and then move it to your own Roth. I left out the while working part and see how that could cause confusion.

I agree with EvenSteven.  People are trying to be clever and take advantage of this new law in ways not intended - a practice which I applaud in general.  But the way it's written, there's really not much opportunity to be clever with it.

If you're semi-retired and have enough income to contribute to a Roth, then just contribute to the Roth then, in semi-retirement.

Doing it 15 years ahead of time via a 529 would start the tax-free treatment sooner.  But you have another account to manage and keep track of.  If the money is destined for retirement/Roth, you could just put it in your 401(k) or do a backdoor Roth.  If you have so much excess income that you want to go into retirement and have maxxed everything else out, then putting it in taxable in an index fund and spending the dividends is nearly the same thing and a lot simpler.  And a taxable account typically will have lower expense ratios than a 529 plan - in my state it would be about 0.25% per year - over 15 years that would add up.

The other cleverness with the 529 idea here is that you might get a state tax benefit with the 529 contribution.  That might be helpful.

If you do this, it's limited to $35K total per beneficiary per lifetime.  If your accumulated contributions plus investments end up above that, then you'd have to figure out a plan for what to do with the excess - take it out and pay taxes/penalties, give it away to a relative going to college, or something else.

[ChpBstrd]

My read is that the account must be 15 years old at the time of withdraw, but the money withdrawn only has to be in there for only 5 years.

So this might be an especially good option for someone who still has an account open from their college days years ago, who is already maxing out their 401k and Roth, and who has a few thousand per year more they'd like to not pay state taxes on. The rest of us might consider opening a 529 now, putting the bare minimum deposit in, and seeing how the options look in 10 years.

Also, if you can only extract $35k five years from now, how much do you need to invest in an index fund right now to hit that number? $24k?

[secondcor521]

My read is that the account must be 15 years old at the time of withdraw, but the money withdrawn only has to be in there for only 5 years.

Generally agree.  There's lack of clarity on how intervening withdrawals are treated (like if you actually are using the 529 as intended and are using it mostly to pay for college etc.), but I think assuming FIFO and a 5 year rolling holding requirement is reasonable if you want to guess before the IRS issues regulations.

So this might be an especially good option for someone who still has an account open from their college days years ago, who is already maxing out their 401k and Roth, and who has a few thousand per year more they'd like to not pay state taxes on. The rest of us might consider opening a 529 now, putting the bare minimum deposit in, and seeing how the options look in 10 years.

And if their state doesn't make moves to add recapture taxes for people trying your clever idea.  Not sure how they would do this, but they have time to figure it out if they choose to.

And if their state tax rate is high enough to overcome the 15 years of fee difference between 529 and taxable.

And if their state tax benefit on 529 contributions is nice enough.

I don't know anyone who falls into that very specific set of criteria.  Maybe they exist.  Maybe you are one or know some.

Also, if you can only extract $35k five years from now, how much do you need to invest in an index fund right now to hit that number? $24k?

That's the other thing.  You get to guess five years ahead of time.  You'll probably be somewhat wrong.  Do you want to be too high or too low?

[EvenSteven]

My read is that the account must be 15 years old at the time of withdraw, but the money withdrawn only has to be in there for only 5 years.

So this might be an especially good option for someone who still has an account open from their college days years ago, who is already maxing out their 401k and Roth, and who has a few thousand per year more they'd like to not pay state taxes on. The rest of us might consider opening a 529 now, putting the bare minimum deposit in, and seeing how the options look in 10 years.

Also, if you can only extract $35k five years from now, how much do you need to invest in an index fund right now to hit that number? $24k?

The upside here would be saving [(capital gains tax rate) x (growth)] + [(marginal state tax rate) x (contribution amount)]

Where in a reasonable situation the growth might be around 20K and contributions of 15K. (this is about a 7% real return over 15 years)


The downside would be turning 20k of capital gains into ordinary income and a 10% penalty on that 20k of gains.


I would say if you think there is a high likelihood of being able to land in that high upside zone, you might put this strategy at #9 in the investment order list, with using the 529 for education purposes at #8, and bumping taxable brokerage account to #10.

For myself, I think there is little chance of ending up in that upside zone, but I only make it down to number 5 before running out of money anyways.