With the passing of the Secure Act 2.0, starting in 2024, owners of 529 accounts will now have the ability to transfer up to $35,000 from their 529 college savings account directly to a Roth IRA for the beneficiary of the account. While on the surface, this would just seem like a fantastic new option for parents that have money leftover in 529 accounts for their children, it is potentially much more than that. In creating this new rule, the IRS may have inadvertently opened up a new way for high-income earners to move up to $35,000 into a Roth IRA, creating a new “backdoor Roth IRA contribution” strategy for high-income earners and their family members.

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For years, high earners have been limited in their ability to contribute to a Roth IRA due to income restrictions. However, a new strategy has emerged that allows these individuals to contribute to a Roth IRA through a 529 plan.

The 529 plan is a tax-advantaged investment account that is primarily used for education savings. However, recent changes in tax laws have made it possible to transfer funds from a 529 plan to a Roth IRA without penalty.

Here’s how it works: contributions to a 529 plan are made with after-tax dollars, and the money grows tax-free if used for qualified education expenses. However, if the funds are not used for education, they are subject to taxes and a 10% penalty on the earnings.

With the new backdoor Roth contribution strategy, individuals can transfer funds from a 529 plan to a Roth IRA. Since the contributions to the 529 plan have already been made with after-tax dollars, the transferred funds can be considered a Roth IRA contribution.

This strategy allows high earners who are unable to contribute to a Roth IRA directly to use a different tax-advantaged account to make contributions. Additionally, since Roth IRAs have tax-free growth, the transferred funds will continue to grow tax-free.

However, it is important to note that this strategy is not without risks. The transferred funds from the 529 plan must be used for the Roth IRA contribution in the same tax year to avoid penalties. Additionally, individuals must ensure that they have enough money saved in the 529 plan to cover any future education expenses.

In conclusion, the 529 to Roth IRA transfer strategy provides a new avenue for high earners to make contributions to Roth IRAs. While there are risks involved, this strategy can be an effective way to take advantage of tax-free growth and contribute to a Roth IRA. As always, it is important to consult with a financial advisor before making any significant investment decisions.