529 as "backdoor" roth and local matching plan

[dizzy]

Question for youse:

I heard on a podcast I listen to recently that one can rollover money now from their 529 to their Roth IRA.  It's part of the SECURE 2.0 act.
Caveats:

The 529 plan must have been open for a minimum of 15 years.
The owner of the Roth IRA must be the beneficiary of the 529 plan.
The rollover is subject to the requirement that a Roth IRA owner have includible compensation at least equal to the amount of the rollover.
Contributions made to the 529 plan in the last five years, including the associated earnings, are ineligible for a tax-free transfer.
Transfers you make from a 529 to a Roth IRA count against your yearly Roth IRA contribution caps, which are currently at $6,500.
The lifetime limit for rollovers is $35,000.

Ooooook.  I mean that's fine, I'm not taking out money for a good long while there (I'm 41)

So in the meantime my state does a one-time matching grant of initial deposit up to $750.
You have to have a household AGI of under $75k, which it currently is.  It probably won't be after this year so I need to get on it in the next few months if I do.

In general I'll be looking for ways to get my AGI down due to my student loans so this seems like a great opportunity to get 100% bonus on that money I put in.  And as a last ditch way to lower AGI in subsequent years if I fill up my solo401k (I won't be able to get tradIRA benefits anymore since starting next year we'll due MFS due to the loans)

Anyone do this before?  I figure worst case scenario is that they cancel the SECURE act bill and I have money I can give to my niece or whatever (we won't be having kids).

[Shuchong]

I haven't done exactly what you're proposing.  (I don't get a state match.)  But I do put money into a 529 because I get a state tax benefit.  I am listed as the beneficiary.  I was originally planning to transfer beneficiaries to my sister (no tax implications, because she's a family member).  And I'll still do that, since she's in grad school and can use the money.  Now, with the Secure Act, I'll continue putting money in and eventually transfer to a Roth.

Like you, I figure I can always find a family member who wants free college money down the road if for some reason the rules change.

(Unlike you, I have a 529 account I opened for myself in 2011.  Then used all the money in it for grad school for myself.  But the account was never officially closed.  I added more money to it this year.  Not sure if my 15 years will be up in 2026 or much later than that, but in a way it doesn't matter -- the money may get converted to Roth at a later date, but it will still get converted.) 

[secondcor521]

It'll generally work, but there are caveats that you didn't list:

1.  The investments inside 529s in most cases have higher expense ratios than equivalent investments inside a Roth.  This will offset your $750 matching bonus.

2.  You can just put the money into your Roth now and it's a lot simpler and probably just as tax advantageous.  It's pretty hard to come up with scenarios where you have extra income that you'd like to put into your Roth now, but are willing to wait 15 years, and then will have includable compensation but not be able to fund a Roth contribution at that point.  And even then, the whole scheme is limited to $35K anyway.

And I'm not sure I understand your comments about lowering AGI.  Contributing to a 529 will generally reduce your state taxable income, but doesn't have any impact on your federal AGI.  And contributions to a Roth, either directly or via the new 529 -> Roth rollover mechanism also do not reduce federal AGI.

Lots of people are trying to take advantage of this new mechanism in the law.  Understandably so, it's a cool law and could be an opportunity, and I'm always looking for loopholes.  In this case, I think the law was written narrowly enough that it benefits the intended audience (parents who overfunded a 529 or who are worried they might).  But it doesn't really benefit anyone else or create any sort of particularly useful loophole.

[dizzy]

Problem is I am not eligible for a Roth directly due to filing married but separate.  From what I read I have to contribute to a tradIRA to then backdoor it to the Roth but without any tax benefit (since married filing separate is not eligible for tradIRA tax benefit either)

So there would be a definite tax advantage now for me to do the 529.  What I didn't realize however is that it's only at the state level- you are correct. That makes sense though.  We do live in a higher tax state (NJ) so I will keep it in mind if I manage to fill up my traditional solo401k limit

[secondcor521]

Problem is I am not eligible for a Roth directly due to filing married but separate.  From what I read I have to contribute to a tradIRA to then backdoor it to the Roth but without any tax benefit (since married filing separate is not eligible for tradIRA tax benefit either)

So there would be a definite tax advantage now for me to do the 529.  What I didn't realize however is that it's only at the state level- you are correct. That makes sense though.  We do live in a higher tax state (NJ) so I will keep it in mind if I manage to fill up my traditional solo401k limit

You can certainly read about the contribution and deduction limits for MFS in Pub 590-A.

I would suggest that there is generally not much benefit to the MFS filing status.  The most common reason younger people seem to think it might be a good idea is because of student loan payments which are income based, and the potential for loan forgiveness.  I generally understand the argument for that approach, but I think the benefits of MFJ and just paying the loan off can mathematically be better for "normal sized" student loans.  I admit I haven't fully done the math though.  On the other hand, I suspect some people get overly excited about loopholes and may not have done the math themselves either.

[dizzy]

I've done the math.  I've gotten two professional consults.

MFS on an income-based plan MASSIVELY reduces my student loan payments.  By a total of about $40k including expected tax bomb and yearly MFS "tax penalty".  I'll have around $350-400k forgiven at that time.

We are leanFIRE (P2) and just over povertyFIRE (me- and I will be baristaFIRE-ing that for years) so $40k makes a big difference for us.

My student loans are outsized to my income or any income it's realistic to think I will ever make (I'm up 5x from when I graduated with this degree 8+ yrs ago.  I work 5+ days a week at that job in addition to my other side hustle jobs that I love a lot more.  I'm burnt out.  We want to adventure time while we still have some semblance of youth and health.). 

I didn't write the rules, I just play the game that uses them to the best of my ability.

[dizzy]

Anyway!

I took advantage of the various deals this year on 529 day, which is....(drumroll)....5/29.

I went whole hog and did 7 deals.  I will have to contribute $4560 across the accounts and then the match amount is $1210.
So that's like 26.5% return right there.

I was pleasantly surprised to find the expense ratios were not bad at all.  I think the most expensive was around .6 or .7% but found ones as low as .06%.

If we take a 7% growth over next 15 years that's about $16k to roll over (right about that Roth limit of $15k total to rollover) which feels like a win to me.  If I had just put the $4560 in normal Roth it would be only $12.5k.  I'll take it- didn't start investing until age 38 and have very little Roth money due to contributing to pretax accounts to get student loan payments down.

[roomtempmayo]

I went whole hog and did 7 deals.  I will have to contribute $4560 across the accounts and then the match amount is $1210.
So that's like 26.5% return right there.

Oooh, that's interesting.  When you say "7 deals," what do you mean?

Our state 529 credit is fairly limited, but good as far as it goes.  It's a max $500 nonrefundable credit for putting in $1000, which starts phasing out in the low 80k range for both MFS and MFJ.  I'm pretty sure that's per tax filer, not per kid or account.