“The correct lesson to learn from surprises is that the world is surprising. Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next.”[1]
Since life is indeed full of surprises, it is advantageous to be able to use an asset or account for a different purpose than originally anticipated. By reason of the Secure Act 2.0 signed into law by President Biden on December 29, 2022, owners of college savings accounts (“529 Plans”) and traditional tax-deferred individual retirement accounts (“IRAs”) can now modify the purpose of a modest amount of account assets. In this month’s update, I highlight how the Secure Act 2.0 provides modest flexibility gains to 529 Plan and IRA owners.
College Savings Plan to Roth IRAs
First, a named beneficiary of a 529 college savings plan will be able to convert some assets to a Roth IRA. Beginning in 2024, the beneficiary of a 529 Plan will be able to rollover the unused portions of a 529 Plan into the beneficiary’s own Roth IRA account. Through this strategy, parents and grandparents could create a 529 Plan that, at the outset, is intended to help with future educational costs. Later, if it becomes apparent that the beneficiary is not able to use the assets for educational purposes, the account could then be converted by the beneficiary into the beneficiary’s own Roth IRA. The purpose of the 529 Plan is effectively converted from an educational savings vehicle to a retirement savings vehicle. The specifics are as follows:
- The 529 Plan must have been in existence at least 15 years before the 529 Plan beneficiary can convert some of the 529 Plan assets into a beneficiary-owned Roth IRA.
- Contributions made to the 529 Plan within the previous 5 years cannot be used in funding the beneficiary’s Roth IRA.
- The amount contributed by the beneficiary to his or her Roth IRA cannot exceed the lesser of (i) the beneficiary’s earned income in that year of contribution or (ii) the Roth IRA contribution limit set by the IRS for that year (e.g., $6,500 for 2023).
- A lifetime maximum of $35,000 per 529 Plan beneficiary can be converted to the beneficiary’s Roth IRA.[2]
Individuals who wish to provide a child or grandchild with maximum flexibility over unused 529 Plan assets should create a 529 Plan as soon as possible to start the 15-year clock.
Traditional IRA for Charitable Objectives
Second, since it was created by legislation in 2006, the “qualified charitable distribution” or “QCD,” allows Traditional IRA account owners the option to direct a portion of their required minimum distribution (RMD) directly to a charity. The QCD allows IRA account owners to repurpose IRA assets for charitable gifting while also avoiding income taxes.[3] The Secure Act 2.0 not only continues the use of this “standard” QCD opportunity, but now provides each taxpayer one opportunity during lifetime to use up to $50,000 to either fund a charitable remainder trust or purchase a charitable gift annuity. As part of the charitable annuity contract, the account owner would be entitled to annuity payments. The account owner would pay income taxes only upon the receipt of the annuity payments.
The implementation of a gifting strategies presented by the Secure Act 2.0 might impact the client’s estate plan. For example, many clients set a “target amount” for total charitable contributions or educational savings contributions, to be accomplished through a combination of lifetime gifting or post-death distributions. In these cases, the legal documents should be reviewed and perhaps updated to incorporate these gifting strategies.
[1] Morgan Housel, The Psychology of Money, P. 128.
[2] The calculation of this lifetime maximum is made at the time of the conversion of assets from the 529 Plan to the Roth IRA.
[3] An account owner older than age 70.5 is eligible to make the contribution directly to a public non-profit charity. The contribution counts toward the RMD amount in the year of the contribution. The Secure 2.0 Act includes inflation adjustments for annual QCDs limits, which is $100,000 for QCDs made in 2023.