College 529 Plans can roll into Roth IRA

Saving for college with multiple children: New considerations The new 529 rollover to Roth IRA - TOPICS/ Personal Financial Planning Education Planning To alleviate some of thechallenges that arise when funds are left unspent in qualified tuition plans,typically called Sec. 529 plans, once the beneficiary has completed their education, a new rule allows limited rollovers from 529 plans to Roth IRAs. This has also created new wrinkles for families with multiple children who have already started or even completed their educations. - Until the new rule goes into effect starting in tax year 2024, beneficiaries with leftover funds in a 529 account have had limited options to use these funds without triggering taxation and penalties on the growth of account assets. For families with multiple children, a helpful practice has been to fund 529 accounts for each child, knowing that leftover funds in one child's account can be transferred to the 529 account of another child should they be unused. - This has worked well and will continue to be a useful option, but the new 529-to-Roth transfer, which was included in the SECURE 2.0 Act (enacted as part of the Consolidated Appropriations Act of 2023, P.L. 117-328) has some parents rethinking these transfers. That rule allows for up to $35,000 to be rolled into a Roth IRA so long as the IRA is in the name of the same beneficiary as the 529 and certain other requirements are met. For background, see "Saving for College: The New 529-to-Roth IRA Transfer Rule," JofA, March 6, 2023. - New choices The new ability to roll funds from a 529 plan to a beneficiary's Roth IRA leaves families with certain options they didn't previously have. For instance, out of a sense of fairness, some parents may want to allow children who don't exhaust education savings that have been set aside specifically for their own use to be able to kickstart their retirement savings through the limited Roth IRA rollover option. (The child could also use the Roth IRA to, for example, help fund a first-time home purchase; see "3 Strategic Uses for Roth IRAs Beyond Retirement," JofA, Aug. 2, 2022). - The issue that arises, however, is that a tax-free transfer of funds to a Roth IRA is available only for a 529 account of a designated beneficiary that has been maintained for at least 15 years. And when the account owner, typically the parent, changes the beneficiary of an account, the 15-year clock resets. (See new Sec. 529(c)(3)(E)(i).) (Note: That the clock resets is a natural reading of the Code section and the safest assumption to make. As of this writing, the IRS has yet to issue guidance on the new 529-to-Roth transfer rule.) - For families that wish to continue the practice of sharing all education savings among their children while still allowing for leftover funds to be distributed to Roth IRAs fairly, there is a potential workaround that is mostly logistical. Rather than changing the beneficiary of an account to make those funds available for use by another family member, the account owner can instead request a rollover of funds under Sec. 529(c)(3)(C)(i)(II) to the other child's existing 529 account, leaving the original account (and its 15-year or longer tenure in the name of the original beneficiary) intact. - There are a couple pitfalls to avoid when employing this strategy. First, rollovers between 529 accounts are permitted only once every 12 months (Sec. 529(c)(3)(C)(iii)), so if funds were recently moved from one beneficiary's account to another, the owner will need to wait until at least a year has passed to reverse that transfer. - Additionally, if the rollover takes place between accounts that were established in different states, there may be tax clawback rules for any deductions taken in the state where the funds are being transferred from. Be sure to check the specific plan's rules before performing rollovers between state plans to plan adequately for any tax consequences. - An illustration For example, let's examine a common scenario that families with current college-aged or recently graduated children are facing. - The Patel family has three daughters. The oldest one has completed her education, the middle daughter is currently attending college, and the youngest daughter is a high school senior. A 529 account was established for the benefit of each daughter when they were born. When the oldest daughter completed school at an in-state university in 2021, she had $5,000 remaining in her 529 account and no plans for further education. - Prior to the 529-to-Roth transfer rule, most families would opt to use the leftover funds for the benefit of other family members. However, the Patels wish to allow their oldest daughter to transfer those remaining funds to her own Roth IRA as a reward for her fiscally conservative education choices. Complicating their plans, however, they have already transferred the remaining $5,000 in the oldest daughter's 529 account to the middle daughter's 529 account, and the funds were used to pay qualified expenses for the middle daughter. At this point, there is no way to reverse that transaction. - However, let's say that the youngest daughter was recently awarded a scholarship that will cover the majority of her education costs, meaning that most of the funds in her 529 account are not expected to be needed to pay for her education. As such, the Patels would like to use some of those funds to return the $5,000 to their oldest daughter's 529 so that she may then perform a rollover to a Roth IRA. - To do so, the oldest daughter's original account must still be open and in her name, which maintains the 15-year time limit for the ability to transfer funds to a Roth IRA. Additionally, the transfer must be performed as a direct rollover between the younger daughter's account and the oldest daughter's account. If a new account is established in the oldest daughter's name, then she must wait 15 years to perform the transfer to her Roth IRA. - In essence, whether the oldest daughter can perform a rollover to a Roth IRA without waiting 15 years will likely come down to how the original transfer of the oldest daughter's 529 account funds to the middle daughter's name was performed by Mrs. Patel, the account owner. - If Mrs. Patel simply changed the beneficiary on the existing account, this would reset the 15-year clock, and the oldest daughter would have to wait at least 15 years to perform the 529-to-Roth-IRA transfer. If, instead, Mrs. Patel transferred the funds from the oldest daughter's account to the middle daughter's while leaving the oldest daughter's account open, this would keep the 15-year timeline intact for purposes of 529-to-Roth-IRA distributions. If the accounts were established in two different states, this could cause unintended state tax consequences. A final option would be to have established a new account in the name of the middle daughter in the same state program as the oldest daughter's, then perform a direct transfer of the funds to the new account. As long as the oldest daughter's account remained open, the 15-year timeline would remain intact while also avoiding unnecessary state income taxes. This option does reset the 15-year rule for the middle daughter, but since she was planning to spend the funds anyway, that is irrelevant. To return the $5,000 to the oldest daughter's name, Mrs. Patel should request a direct rollover from the youngest daughter's 529 account to the oldest daughter's, noting again that there could be state income tax consequences if the two accounts were established in different states. - The 5-year rule for new contributions One other common question is how the IRS will apply the separate requirement of the 529-to-Roth transfer rule that no contributions to a 529 account, or earnings on those contributions, from the last five years can be rolled over to a Roth IRA (Sec. 529(c)(3)(E)(i)(I)). A reasonable reading of the Code is that transferring funds from one 529 to another will not be considered a contribution for purposes of this rule. In other words, the five-year clock will not reset. - Exhausting remaining funds when all children have completed their education A separate question on the Patels' mind is how to minimize the amount of leftover 529 funds when all the daughters have completed their education. To address the possibility that the youngest daughter will complete her education with a significant balance in her 529 account due to her scholarship, the family might consider any of the following additional planning moves to minimize unnecessary taxes and penalties while allowing their daughters to enjoy the funds set aside for their educations: - Have the middle daughter accept up to $10,000 in federal student loans to pay for her final education costs, then transfer $10,000 from the youngest daughter's 529 to the middle daughter's to pay off the loan upon graduation with a tax- and penalty-free distribution under Sec. 529(c)(9) (added by the SECURE Act of 2019, P.L. 116-94). This has the added benefit of boosting the middle daughter's credit score. Have the youngest daughter do the same, for the express purpose of withdrawing $10,000 from her 529 tax- and penalty-free. - - Begin 529-to-Roth-IRA transfers for the benefit of the youngest daughter as soon as she has earned income, until the aggregate total of transfers reaches the $35,000 limit. Remaining funds at that point could be transferred to the middle and older daughters' original accounts to allow them to perform 529-to-Roth-IRA transfers up to the $35,000 limit for each, as long as the 15-year timeline is met. - Any remaining funds can be kept in 529 accounts for the benefit of future grandchildren or other family members. For families who performed 529 beneficiary changes prior to the passage of the SECURE 2.0 Act, the ability to return unused funds to the original beneficiary for Roth IRA distributions will probably depend on whether the 15-year timeline is still intact or if it was broken due to the administrative choice made when funds were allocated to a different beneficiary. Each 529 administrator is likely to treat this transaction differently, so the most reliable source of information of whether a beneficiary can be deemed as having an account for at least 15 years will be the plan administrator. - Note, finally, that certain aspects of the 529-to-Roth transfer rule will become clearer once the IRS issues guidance. This article is intended to help readers plan in the meantime. — Kelley C. Long, CPA/PFS, CFP, is a personal finance coach and consultant in Arizona. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld at David.Strausfeld@aicpa-cima.com.

IRS close to mandating Efile for tax returns

July 28, 2023 To combat fraud, IRS steps up ERC claim enforcement TOPICS Tax IRS Practice & Procedure Former IRS Commissioner Mark Everson compares the efforts of the IRS to go paperless to the interstate highway system of the 1960s, when he was a child. "You would drive from New York, where we lived, and I-95 ended in Providence," he said in an interview with JofA. "You'd be doing great and then, all of the sudden, bingo, there was no more interstate. "That's how the IRS has been operating. It's got certain forms and activities that have been automated and others have not." Until this week, that is. With much fanfare, the IRS announced Wednesday that by filing season 2024, taxpayers will be able to file most returns and documents electronically. And by filing season 2025, the IRS will digitize all paper-filed returns when they are received. If the IRS can meet these goals, the Service will curb the deluge of paperwork that overwhelms it each year. The IRS receives about 76 million paper documents each year. Scanning those paper returns will put an end to the work of entering the information by hand, keystroke by keystroke. "This is a big watershed moment that's approaching," said Everson, who served as IRS commissioner from 2003 to 2007 and now is a vice chairman of alliantgroup, a tax and business consulting group that works with over 4,000 CPA firms nationwide. "And it will make a difference to the taxpayer service." Treasury Secretary Janet Yellen and IRS Commissioner Danny Werfel emphasized the improved taxpayer service when they provided details of what they have dubbed paperless processing initiative during a visit Wednesday to an IRS facility in McLean, Va. The initiative "is the key that unlocks other customer service improvements," Yellen said in prepared remarks. "It will enable taxpayers to see their documents, securely access their data, and save time and money. And it will allow other parts of the IRS to rely on these digital copies to provide faster refunds, reduce errors in tax processing, and deliver a more seamless and responsive customer service experience." The announcement by Yellen and Werfel was not the first word of a paperless IRS. National Taxpayer Advocate Erin Collins told participants at the AICPA & CIMA ENGAGE 2023 in June that the IRS would be paperless by 2025. The Service will convert any paper files from taxpayers to digital before processing them, she said. Besides the electronic filing and digitization of incoming paper forms that are part of the initiative, older documents will also be digitized, which will give taxpayers access to their data and save the IRS about $40 million in annual storage costs, officials said. The move toward a paperless IRS has been at least 25 years in the making. In 1998, Congress passed the IRS Restructuring and Reform Act, P.L. 105-206, that said "paperless filing should be the preferred and most convenient means of filing federal tax and information returns." It set of goal of having at least 80% of all such returns filed electronically by the year 2007. And while approximately 94% of individual tax returns are now e-filed, millions still file on paper. Coupled with budget cuts, staffing shortages, and the effects of the COVID-19 pandemic this led to what was one of the most telling images of the IRS paper backlog: a photo of thousands of pieces of paper packed into what was supposed to be a cafeteria at the IRS campus in Austin, Texas. Werfel referred to that photo in his remarks Wednesday in Virginia. "The amount of paper still being used inside the IRS often feels more like the 1970s and 1980s than the 21st century," he said. "During the pandemic, you saw the photos of the IRS cafeteria in our Austin campus with racks and racks of paper absolutely filling the room not normally used for storage. Tens of millions of pieces of paper that require manual processing flood our campuses and offices. It is time to ensure that no cafeteria in the IRS ever looks like that again." The improvements are courtesy of the Inflation Reduction Act, P.L. 117-169, which provided the IRS with $80 billion over 10 years. The debt ceiling deal reached earlier this year deleted about $20 billion from that amount. "A digital IRS rather than a paper IRS is exactly what the was intended when Congress provided new funds under the Inflation Reduction Act, and our announcement today shows that we are taking steps to make on that promise," Werfel said. Early in his tenure as IRS commissioner, Everson said he mandated that large corporations and not-for-profits file their returns electronically. Since then, the Service has made "regular strides" toward electronic filing, but "the problem has been the ups and downs of the regular budget," he said. Continued, guaranteed funding equals a better IRS, he said. "The reason this is good is they have this pot of money, and they have the confidence that they'll have enough money to finish things," he said. — To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.