Financial planning with 529 plans has changed in a big way. What was once just a college savings tool can now become a powerful strategy for long-term, tax-free retirement wealth when used correctly. In this episode of the Wise Money Show, we break down the new 529-to-Roth IRA rules, who this strategy works for, and the key pitfalls to avoid. Learn how this little-known opportunity could potentially create six or even seven figures of retirement income over time.
Season 11, Episode 22
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Transcript: How a 529 Plan Could Turn Into a $1 Million Tax-Free Retirement Strategy
It’s time for wise money with Korhorn Financial Group with certified financial planners Kevin Korhorn, Mike Bernard, and Josh Gregory.
Segment 1: Welcome to another episode of the Wise Money Show with Korhorn Financial Group, where every week we’re helping you take your next wise step in your financial life. Thanks for being here, friends. My name is Mike Bernard. I am your host. I’m also one of the certified financial planners on the program. And with me in the KFG studios, my business partners and fellow CFPs, Kevin Korhorn and Josh Gregory. and friends. Okay. Planning with 529 plans recently got a lot more interesting thanks to new rules. So, what was once just a college funding tool uh is now something that can be used for a lot more purposes when done correctly and could even lead to a million dollars or more for retirement. We’re going to explain this new potential and the new rules in this episode. Yeah, it’s very complicated, but it is it has significant potential and we’re going to break it down, tell you the the who, what, where, why, and how, and the rules for you to consider implementing this unique strategy in your financial situation. Uh, if you have a question for the program, we’d love to hear from you. You can call or text us 574222000. That’s 574222000 online. WiseMoneyShow.com is where you can find us. And then all over social media, wherever you’re at, we are there as well. Search the WiseMoney Show. So, like Kevin said, yeah, there’s this new opportunity with planning for 529 plans. These used to be just for college, then it became K through 12. Then there’s the option for even helping with some student loans a little bit, and they’ve expanded the rules even more with the most recent tax laws. But in the Secure Act 2.0, which was Yeah, you we don’t expect you to remember that. It was passed a few years ago. a new rule allowed you the potential to use your 529 plan, use the 529 plan for retirement purposes. And this is this is something very very few people are doing. But I think over the next several years, over the next decade or more, this could be an enormous strategy. And like Kevin said, could be six figures, even seven figures for retirement. Before we get into that, let’s just talk about the rules in general. What’s a 529 plan? How does it work? Yeah. Well, and you guys have both alluded to the fact that 529 plans have been evolving. Man, if if you go to sleep on the rules with 529 plans and wake up, uh they’ve probably changed in in some way. They just continue to to get adjusted. They’ve always been about higher education. It’s a a vehicle. We’ve often referred to it as an education savings vehicle. that’s its main purpose. You’re setting money aside after you’ve already paid tax on it and getting it invested for a long period of time hopefully. Um could be many many years that you’re accumulating money for either uh college, some some sort of higher education, could be trade uh or technical school. Now, yes, also K through 12 is is in there as well with some limits on what you can spend there. But the the point is it’s a place to accumulate money and let the dollars grow, compound. You you want to be invested in mutual funds usually and um it’s a way for you to to just amass a number of of resources so that you can help pay for these expensive um education uh goals and everything. when you pull the money out, as long as you’re using it for those qualified purposes, think tuition, room and board, uh some of the required fees, even like a a computer, uh or some sort of required equipment for for education. Um then it comes out and you don’t pay tax on the growth. So, the fact that this is a tax shelter is really where all the power comes into play. And what we’re talking about today is how do you leverage that tax shelter for even longer than just the college saving years. I I mean guys, we’re talking about decades and decades. It it’s not even a stretch of the imag imagination to say you’re sheltering dollars completely from Uncle Sam for 80 or 90 years. Think about the potential of that. So the 529 plan, the basics are at a federal level, your contributions, you don’t get a tax benefit for it. You make it a state tax benefit for that. work with your CFP, understand those rules, but no tax benefit on the way in. Tax sheltered growth, so dividends, interest, capital gains, they don’t land on your tax return every year. And then if you withdraw the dollars for a qualified purpose, which like Josh said, often college expenses and and tuition room board, those sorts of things, books, computer, then the dollars come out taxfree. Well, this new rule really started just recently. You are now allowed to transfer money from that 529 plan to the Roth IRA. I mean, think about this. So, how’s the Roth IRA work? We used to call the 529 plan really the the Roth but for college because it’s mechanically the same thing. It’s after tax money in tax sheltered growth and then you pull the dollars out tax-free. It’s just well when can you do that? Well, you got to have had the Roth IRA for five years and you need to be age 59 and a half. If you can successfully navigate this, and we’re going to break down the the top five rules that you need to be aware of here in just a second. If you can success successfully navigate this, guys, we are talking about potentially a million dollars of retirement just from this strategy. And when you actually calculate well all the compound growth for all of that to be tax-free and and avoid Uncle Sam completely in that process, we’re talking legacy an enormous impact. That’s exactly right. Essentially, we’re talking about stacking together or putting in succession a tax shelter that was meant for college or for long-term education, letting the money then flow into a tax-free uh savings vehicle for retirement without paying any tax in between. That’s the key. In the past, you always had to be real careful when you were piling money into a 529 plan that if you ended up pulling the money out after the college years were all done and you used it for something else, then you were going to end up paying taxes and maybe a 10% penalty on the growth that had accumulated. May not have been the end of the world, but every extra dollar that goes to Uncle Sam is a dollar that could have been working for you. In this case, there’s there’s a a bridge essentially between the 529 plan and the Roth IRA, and it is a tax-free bridge if you play your cards right. Okay. So, let’s let’s start quantifying some of the potential here. And and it’s really it’s really tricky to do math on the radio, but we’re going to if we play our cards right, we might be able to pull it off. um the entire purpose, the intention around if you’re if we’re trying to give Congress any credit at all. Um that they some folks are nervous about contributing to a 529 plan because what if my child doesn’t go to school? And like Josh, you mentioned, if you withdraw the dollars for something not for college purpose, there’s that you give up that tax benefit and you even pay a little bit a penalty. This is even a a a bigger question when it comes to the potential of AI out there 5, 10, 15 years from now. this college look different. Okay, does that make you pause a little bit with contributing to the 529 plan? This creates that bridge. Now, we’re going to talk about some of the rules here in just a minute. You might be familiar, odds are you’re familiar with some of them, but $35,000, that’s that’s the lifetime limit of this. That’s one of the rules we’ll hit at in into a Roth IRA at say age 22. an 8% compound growth rate, which the stock market compounds at has compounded at a higher rate than that. Say you’re diversified, say you adjust risk down over the years. Let’s say 8% is something that you can discipline and and stick with and disciplinely achieve over 45 years. So from age 22 to 67, that 35,000 can grow to over a million dollars. Not too much, you know, not not not too much of a stretch of imagination to get there. Will, if that happens, will you spend that entire million dollars or so immediately? No. It’s still in the Roth, still growing and potentially could be there for the three decades of that retirement and then pass along to the to the next generation. Guys, I mean, this could be a hundredyear strategy with a lot of compound growth all sheltered from Uncle Sam. Yeah. And I I can save some people who want to uh head to the comment section right now and say, “Wait a minute, you can’t put $35,000 in in one year.” And that’s fine. Um and it because it has to be based on the child’s income. So if the child gets out of school right away and and lands this job that prevents them from contributing to a Roth IRA, that’s an issue. So, I mean, there there are some things that we have to kind of un unpack here. Well, and that’s important to recognize that each year they’re contributing to the Roth IRA. They’re just not using money from a paycheck or money they already have in the bank account. They’re transferring dollars over from the 529 plan, but you’re limited in uh whatever the Roth contribution limits are in that year. Okay. So, we’re going to get into these rules, but we’ve got I’m looking at the clock. So, Kevin, just a couple rebuttals for th those that are thinking about it. launching your career. Number one, do you need to contribute to a Roth IRA or could you just have all those dollars be going into the Roth or to the Roth 401k? Yeah, that could be even if that child is saving for college, you could have them channel all those dollars into the 401k likely not hit that match and maximum and use these dollars to fund the Roth. The other thing is if you play your cards right, even that part-time job that that child is doing when they’re 18. Yeah. or when they’re 19 or when they’re 20, you can be siphoning and using this bridge from the 529 plan to start funding that Roth IRA. So, we we want to share the rules, okay? So that you can know, well, if this strategies for you, how do you do it? We’ve got that more coming up here on the Wise Money Show with Korhorn Financial Group.
Break 1: Hello YouTube. Thanks for being here. This is the Wise Money Show. What you’re watching right now is our weekly 1-hour talk show that airs right here on this channel, 10:00 a.m. Eastern time every Saturday morning and also on podcast at the same time and also on a couple local radio stations at the same time as well, which is why the content’s structured the way that it is. It is a is it’s a talk show, so it’s long form. We’re going to go off track. We’re going to meander. We’re going to challenge each other and and hopefully that is helpful and beneficial to you. But if you’re looking for something more concentrated, more direct, something that states these rules in a punched way, right? Uh we’ve got next wise videos they air right here on this channel as well all throughout the work week as well as shorts and other uh shorter content to help you take your next wise step in your financial life. So make sure you hit that subscribe button, turn on notifications so you’re made aware every time we drop new content. If you like the content, like the content, and leave questions and comments below, like Kevin said, want to hear it. I mean, would you consider using this strategy right now? I I’ll do it. We’ll do this math right now. The first time we talked about this strategy, we did this math. How much contributed day one gets you to 35,000 by age 18? About 10 grand, 11 grand. So if you had the resources, so that might be an approach that a grandparent might take. Yeah. Right. Yeah. Throw throw 11 grand and who knows, right? No one knows what the market’s going to do. Throw 11 grand in the first year that that child is born. hopefully compounding at a decent rate. We don’t have any lost decades, that sort of stuff. That could go to around 35 grand by the time they’re in college or after college. And then that 35, you start feathering over into their Roth and you’ve turned 11 grand into over a million by the time that child or grandchild in this case is 67. They’re not going to spend all that right away. So, it’s continuing to grow compound. I mean, the potential is enormous. I mean, it requires coordination with the parents, too, right? It’s not going to happen by accident. Exactly. Um because most parents are going to be trickling money in throughout hopefully the child’s entire lifetime, but sometimes they wait a few years before they can afford it or or whatever. But yeah, so that’s an interesting strategy. And you know, they say, “Don’t do math on the radio.” But if you said, “I I just want 35 grand in there by the time my grandchild hits 18.” Mhm. Then you put 75 bucks a month in and grow it at 8%. And you get there. What’s wrong with that strategy? Uh we’re going to get to one of the rules here in just a second. The last 5 years don’t count. contributions. But it could be actually it could be absolutely perfect because the you could take you the first 13 years worth of contributions and uh fund the first two or three years worth of contributions. Feather it in cuz or you just say, “Hey, I’m going to fund it 75 bucks a month. By the time my grandchild’s 18 at 8%, they got 35 grand. We’re going to wait 5 years. We’re going to get them through education just like I talked to some folks. Hey, you want to help your kids with education? Pay for the last two years, right? Don’t pay the first don’t pay for the first two or whatever. It’s easy to say when you’re on the radio. It’s I’m going to say it’s impossible to do with your own children, but uh man, do I have great ideas when it doesn’t involve me. That’s why you’re a financial planner. I’ll buy I’ll buy you lunch cuz we’re at that stage. So, bring the ideas. Well, dude, you I’m telling you, you take all these ideas and you say, “Oh, that they I was such a perfect parent till I had children.” Oh my. All righty. Here we go. Let’s get into the rules. And we’re not going to get through all five here in this segment, but maybe if we can in the se segment two and three, that’d be awesome. Or did I break it down into the four rules because I wanted it to fit? I did. Four rules. Here we go.
Segment 2: Could you use a 529 plan to make a million dollar difference for retirement? The laws say it’s legal now. However, it’s not going to happen by accident. Takes coordination between family members, financial planners, tax advisors as well. It’s just it it is a very potent strategy very few people are utilizing. We’re going to share the rules on how you can pull it off right now. This is the Wise Money Show with Korhorn Financial Group. Thanks for being here. My name is Mike Bernard with me in the KFG studios, Kevin Korhorn and Josh Gregory. Stay up to date on all wise money content. Find us online, wisemoneyshow.com and then all over social media wherever you’re at, we are there as well. Search the Wise Money Show. Yeah. The Secure Act 2.0 now made it legal to transition. Josh, I loved how you said created a bridge from a 529 plane to a Roth. if it was only that easy. There’s like trap doors on this bridge and it’s one of those shaky ones, you know, a mile high. So, you might be sort of scared to walk across it. We’re going to share those rules with you right now. Rule number one, if you want to explore this maneuver, first rule you need to know to do this successfully is the 15-year rule. Guys, we’re familiar with the five-year rule with the Roth, or at least sort of. We’ve done a lot of shows on it. This is a 15-year rule. How does this one work? Well, this is it’s good that we’re starting with this one because this one you can’t uh you know make up just because you uh have the idea now I’ve got a 529 plan or I’m getting ready to start one right before college. No, this had to have been something that you put in place early in that child’s life so that the account can be just open long enough for you to be able to use this this bridge that we’re talking about. 15 years it has to be open. doesn’t mean that all the money that you’ve contributed has been in there for 15 years. Um, but the account has to be open. And and there are other places that you hear us talk about get your five-year clock ticking like with a Roth IRA. This is this is now a 15-year clock that you need to get rolling on a 529 plan. So somewhere maybe around age 6, 7, 8, you want to be having the 529 plan open if you haven’t done it even earlier than that. So this I Congress was intentional with this. I think they’re trying to make sure that this strategy which is very very unique and has a lot of potential isn’t done like a last minute hail Mary. I’m just going to skirt the rules. No, the intention is saving this money for college and then if you’ve got money left over, you can you can build a bridge. Now, one of the other rules or I’m tucking into this first one and and I’m tucking it in because it’s the IRS is still not clear in in having interpreted this. You can ch with a 529 plan. There’s three entities. There’s three parties involved. There’s an owner of a 529 plan. There’s a successor owner, so who’s in charge if the owner passes away? But then there’s a beneficiary, which that term typically means something else in every other context except for the 529 plan. Whose benefit is this account for? And so who’s the student? In other words, who’s the student? That’s right. You can change this beneficiary a lot. Does the bene does changing the beneficiary restart the 15-year clock? The belief is that it does. That should be your operating uh the way you’re operating. The IRS might come out when they interpret these rules finally and say, “You know what? Actually, it won’t.” Every basically the industry’s expectation is they’re going to say, “No, changing the 15-year, excuse me, changing the beneficiary will restart the 15-year clock.” And I think that’s logical because the reason the 15-year clock is there to begin with is they don’t want someone sort of uh manipulating these rules and just taking advantage of the situation now that this rule exists where you can then say, well, I’ve got this I’ve got this account and this person’s name and I’ll change it at the last minute because this person isn’t able to fund their Roth and I want to be able to do that. So, you’ve got to have a the A529 plan open for at least 15 years. If you change investments, that doesn’t restart the clock. If you change beneficiaries, I would act as if it will. All right, that’s rule number one. Closely connected to that is a frustrating rule, and that’s rule number two. It’s the five-year contribution look back. How’s that one work? I so basically this says that um for you to be able to move money for from the 529 plan to the Roth IRA, the money has to have been in the account for longer than 5 years essentially. Or to to say it differently, the money you’ve been contributing in the most recent 5 years isn’t yet eligible to make the transition from the 529 plan over to the other. This is meant to be long-term money that has been in the 529 plan. It’s extra didn’t get used for college or or um private school or something like that and now you’re using it for some other purpose. This is meant to be kind of backup plan. We’re talking about it as a primary strategy in a way here today. But um it it’s part of the way that Congress I think it’s it’s these two rules together are meant to be protecting um from people just utilizing this for their own benefit. Um because you have to recognize that that bridge from the 529 plan over to the Roth is potentially creating a backdoor for some people to be able to make a contribution who wouldn’t otherwise be able to because their income’s too high. That’s right. We’re going to talk about we’re going to talk about that in rule number three. But but there is no income limit on this, but you do need income. We’ll get to that here in just a second. I Let me give an example here with this 5-year contribution look back. So, you open up a 529 plan and just throw a couple shekels in it to get that 15-year clock done and then you start realizing, okay, nope. I think I am going to want to use this for the beneficiaries uh Roth and so let me start throwing some money in there because now I’ve got I’ve got this this this vision. the IRS, that wasn’t the original intention. And so they don’t want this to be a lastm minute sort of strategy. And even though this frustrates a lot of people, and I’ll tell you, it frustrates the 529 plan because not only is the are contributions made in the last 5 years ineligible for that Roth bridge, the growth on those contributions in the past five years are not eligible either. But this, if you’re nerding out like me, I think you’ll see that this is okay because the most amazing part of this bridge Josh mentioned in the first segment, and that is when you transfer this money from a 529 plan to the Roth IRA, it’s not taxable. Well, what’s not taxable? Well, it’s the growth, right? It’s it’s the growth on it. That’s what we’re trying to preserve, the tax sheltering of the growth. Well, if you’ve contributed money to the 529 plan within the past 5 years, unless we’re seeing like in just an unbelievable rally in the market, there likely isn’t a ton of growth anyway, so it’s not super penalizing. You just need to know that this rule exists. Got it. Anything else? Well, and to me, if you said, “What what should I be thinking about if I if I’m planning?” I would encourage you to be funding the tax shelters that are available to you. and we live right on the border of Indiana and Michigan. I I sleep in Michigan and live in Indiana. And so you say, “Well, what so what do I what do I do?” Well, I actually have income in both states. It’s just kind of how it works out. So I can contribute is as long because if you said, “What are the benefits of contributing?” I would say contribute up to the amount that you can get a benefit for. So in the state of Indiana, if you put $7,500 in, you get a 20% credit. That is sweetness. That is 1,500 bucks back if you Now it’s a what do they call a refundable credit like non-refundable non right non-refundable so if I don’t have enough state income tax not county just state income tax then I don’t get all of it but if I have all of if I have $1,500 of state income tax I get a credit in Michigan if I’m a couple I can put $10,000 in the 529 plan and get the a state ded tax deduction on 10 grand. So that’s about $400. Either way, there’s a tax benefit if you live in Indiana or Michigan. And whatever state you live in, I would make sure you understand what are the goodies. Yeah. And and and what are the benefits? And even if you live in a state where there’s no state income tax, the power of tax deferral is amazing. And that’s what you should be talking about with your financial advisor. Rule number three is there’s a lifetime cap on this transfer on how much money can go across this bridge from the 529 plan to the Roth IRA. And that’s $35,000. That’s that’s what we were talking about in the first segment. You know, why did we pull $35,000 out of our hat? It’s because that’s the lifetime limit. But you can’t do all of that in one foul swoop. It’s got to be applied based on the annual contribution limits to the Roth IRA. This year that contribution limit has increased to 7500. It has been seven grand. So you’ve got to do it peacemeal like one piece at a time, but you’ve got to track that lifetime limit of 35,000. Guys, I am not sure yet if there is another tax form that helps you document like an 8606 type tax form where it documents your lifetime uh you know the transfers. I’m assuming there needs to be one. And if the IRS doesn’t have one yet, it’s on you to be tracking how much have you done with this. But that lifetime limit is $35,000. That’s rule number three. Rule number four though is a biggie. Okay. And then from there, once you have those rules, how do you apply it? What are the advantages? What are the things to watch out for? We’ve got that and more coming up on the Wise Money Show with Korhorn Financial Group.
Break 2: Oh, this is so dense. I don’t even want to do bonus content. Lindsey, are you okay with that? Yep. Because uh Yeah, this is You want to keep the total length short? Yeah, I do. Because it’s just it’s just heavy. It feels heavy. It’s heavy. He’s not heavy. He’s my brother. All right. All right. Then we’ll hit rule number four and then we’ll get into planning strategies and advantages. So this is where we can debate and discuss like where would this fit you know grandparents is you know so anyway we’ll we’ll get into that third segment here we go
Segment 3: What are the rules and what are the benefits when you are exploring this advanced tax planning strategy that’s now available of transferring some of your 529 plan to a Roth IRA this has enormous potential six figures if not Seven over a lifetime of tax sheltered, tax-free growth if you follow the rules. What are those rules? We’re helping with that right now. This is the Wise Money Show with Korhorn Financial Group. Thanks for being here. My name is Mike Bernard. With me in the KFG studios, my business partners and fellow CFPs, Kevin Korhorn and Josh Gregory. Every episode of the Wise Money Show is on podcast wherever you listen. Just search the Wise Money Show. Subscribe to it there. Rate their program there as well. We appreciate it. It’s this is dense. This is a complicated strategy. Very very very few people are doing it. We’re we’re helping a handful of folks with it over the past year. I think as we move forward, more and more people are going to wake up to this new strategy of transferring tax-free $529 into Roth. Here’s the problem, though. If that light bulb moment doesn’t come for you until it’s too late, you won’t realize its potential. or like we’ve talked about with a few of these rules, you’ll just have opted out to begin with because you haven’t had a Roth or excuse me, a 529 for 15 years. You haven’t been contributing. So, the only dollars you would be contributing would be locked out because of the five-year contribution look back. So, you’ve got to have a a long view, a long vision in order to take advantage of this. Rule number four, and and this is a biggie. And when Congress was first kicking around this idea inside the Secure Act 2.0, You know, I I first said, “This is not going to happen. They’re not going to do this.” And then when they did pull it off, I thought, “Okay, wow.” Well, one of the gotchas is this is the Roth IRA of that beneficiary. And I know that’s sort of already been implied, but that that catches a lot of people by surprise. And you need to know that this rule exists with the 59 plan. It’s the owner, successor owner, and then the beneficiary. So, who’s the student? You can’t, even if you’re the owner of the 529 plan, you can’t transfer it into your own Roth IRA. It’s the Roth IRA of the beneficiary of the student. That’s whose Roth IRA it’s eligible to go into. And that beneficiary, that student needs to have earned income. We said in the previous rule that the lifetime limit on this transfer is 35 grand, but you can only do a transfer up to the annual Roth IRA contribution limit. So therefore, each year, so therefore, that student or that that child or grandchild, if they are working part-time and they earn three grand, you can transfer three grand. If they’re working a ton and they’re earning 50 grand, well, you can transfer 7,500. if they are earning $350,000 and they’re not eligible to contribute directly to a Roth IRA themselves, you can still make this transfer. So that’s all baked into rule number four. Yep. I And you just have to recognize that this money was meant to be set aside for that beneficiary or that student. it didn’t get used for their benefit and now you’re transferring it for the benefit of their retirement essentially, not your own. Yeah. And and that’s why when you really geek out on this and say, well, if you’re doing this, you’re likely doing it when they are either in college or typically the five or so years after college, so they’re they’re in their 20s. Well, it’s it’s contributions to the Roth IRA, so they’re not going to use the money in the short term. The soonest they’ll use it is age 59 and a half. some 30 years later, 35 years later. And so therefore, the the compound growth is is significant if you just have this, you know, proactiveness and this forethought um and uh and obviously the resources as well. So guys, we’ve been touching on this throughout uh as we’ve talked about the rules, but let’s just shine a spotlight even on some things that we’ve already said. Very few people are doing this. It has enormous potential for those that it’s a good fit for. What are the big advantages? What are the big reasons to stop, pause, and say, “Wow, this is complicated, but let me understand this to see if it fits for my situation. What are the big planning advantages?” Well, to me, this would be if we were talking to a room full of college students right now, one of the things that we would be trying to impress upon them is the power of getting started in their long-term savings as early as possible. And when you are young in your career, just getting started, it might feel like, boy, I have nothing but expenses and I don’t have any resources. So, thinking about retirement is crazy talk. But the the power ultimately is that you have so much time to let this money compound. And so to get started early, to get into the habit of contributing, even if it’s coming from 529 plans that you didn’t save, the act of getting it into a Roth IRA and committing yourself to um steadily contributing to accounts that are maybe money that you’re going to spend literally decades down the the road. and it’s growing in a tax-free environment. That is unbelievable the the kind of impact that that can have in your financial future or maybe even your own kids and grandkids further down the line. So, I mean that to me that’s the clear benefit number one is the head start. That’s the most common phrase when new folks reach out and they come in to our offices for the first time and they start learning about the financial planning process. inevitably there’s this there’s this moment where they just ah I should have gotten started sooner and and and typically that means I should have gotten started on the planning process sooner but I think everyone in their financial journey oh I I wish I’d have started saving sooner and this gives those kids or grandkids a head start not only saving sooner but also just getting used to and understanding how these investments work right I mean not that many 21 year olds coming out of college start to accumulate the knowledge and the experience of just the ups and downs of the market and hopefully learning how to not let their emotions get uh too out of control when the market takes its next dip. Right. Right. But you should for sure be looking for tax uh tax shelters, but also tax benefits. And so this is where I can have an account. What are the tax benefits? Well, you can get a credit in some states. You can get a deduction in some states. But in any state that you’re in, whichever 529 plan you’re using, you get the power of tax deferral. Yeah. And so, and this is where, and I remember uh you know, when when you could put $2,000 into an IRA, and I would tell folks, hey, look, you don’t you don’t qualify to have a deductible IRA, but you should still do this. And I remember kind of having a little bit of an argument with the CPA. He’s like, oh, you don’t want to do that. That messes everything up. And I’m like, no, no, no. They do want to do that. And then what do you know? They came out with the Roth IRA. And these folks that have been funding these after tax IAS, put that money into their Roth IRA. And and this is the same thing with the 529 originally just for college. And then what do you know? They open it up? No. K through 12. And then what do you what do you know? They open it up. No. K through 12, college, trade school, uh, and Roth IRA and student loan. reduction. Yeah. Up up up to a certain limit, 10 grand over your lifetime. So So yeah, that second benefit is tax sheltering. And you don’t really recognize the power of that until it’s until it’s too late because it you’re either going to be building wealth up where every time interest or capital gains or dividends occur, they’re going to impact your tax or they’re not. And and it’s comes what really slowly and then suddenly. was one of the phrases we we used recently in one of the shows or quote that we uh recounted. And so you want to be building wealth in a tax sheltered way. That’s second benefit. Third, and we talked about this already, and it avoids the the concern of overfunding a 529 plan and having to pull dollars out penalized. Now, we’re talk about one of the disadvantages here in in just a a little bit, but pulling the dollars out of your 529 plan and transferring them following these rules to the Roth, it there’s no tax on that growth and it’s not penalized. And yeah, the the question about uh what impact artificial intelligence is going to have on college education, on getting a start in your career. Like this bridge helps ease I’m not going to say removes a lot of those concerns, but it helps ease a lot of those concerns. You can still be funding a 529 plan. Yeah. You might be a parent right now having conversation with your high schooler saying, “Mom, dad, I don’t need to go to college in order to get an education.” And in many ways, they’re right. You know, everything that they might want to learn is at their fingertips. You can ask AI to teach you about anything these days. That’s not the same though as getting a college education. It’s not the same as the maturing process and everything. So many families are still going to continue to choose to send their kids to college because of the experience of it beyond just the education as well. But if if you are and there are leftover resources because your kids are uh able to get part of their education handled in high school, that’s pretty powerful, too. Yeah, that’s right. All right, we’ve got the mistakes you need to avoid in this strategy. We’ve got that more coming up on the Wise Money Show with Korhorn Financial Group.
Break 3: Sorry, I looked up and saw after 10. Whoa. You’re you’re all right. Okay, we land on the plane. Landing the plane. So, it’s um hitting these mistakes and pitfalls and then if there’s time, resetting and casting the vision. And I know we’ve said it a few times, but I just don’t see there being an opportunity to get into a question or to go a different way. So, yeah. All right. And I’m going to start with number four if you’re looking at the list. Asset location efficiency or coordinate with state benefits. No, coordinate with state benefits. Okay. Yeah, that’s a that’s the biggie. And I I want to make sure that’s the surprise. Yeah. And that Yep. That one’s going to feel like, well, this whole thing was penalizing. It wasn’t. It wasn’t. No. If you gave me money and let me use it for a number of years and I had to give it back to you. Mhm. I’m good. Doesn’t feel like it. No, it feels like a kick in the shorts. Mhm. All right, here we go.
Segment 4: Thanks for being here. This is the Wise Money Show with Korhorn Financial Group. My name is Mike Bernard. With me in the KFG studios, Kevin Korhorn and Josh Gregory. every episode of the Wise Money Show. If you’ve missed any of today’s show, you can catch it on the YouTube channel as well as a lot of other content there. Next wise videos that air all throughout the work week and shorts are there as well. Go to YouTube, search the wise money show. What we’re talking about today is very complicated. It’s very heavy. It’s a strategy you do need to understand. You don’t need to know all these rules, but you need to know enough so that you can have an educated conversation with your CFP to say, “Yeah, let’s do this or here are the here are the reasons why we wouldn’t.” Even if your CFP hopefully they are bringing clarity, confidence, and creativity. But sometimes these rules get so complicated that that that creativity does the opposite of creating confidence and and clarity. And so, uh, work with your CFP to see if this strategy makes a lot of sense. The strategy we’re talking about is 529 to Roth. We just hit all the rules. We hit the advantages. There are some pitfalls. There are some mistakes you need to avoid. And, and let’s just start with the first one that has to be at the top of the list. In Indiana and Michigan, Kevin shared, we’re right on the border. I uh, I live in Indiana. And of all of the states that have a state tax benefit on contributing to your state’s 529 plan, Indiana, I’m going to say, has the best. Okay? And because it’s a 20% state tax credit on the first 75 uh00 bucks that you contribute each year, and that’s per tax return, okay? So, it’s not per child or whatever. It’s $1,500 of tax benefit. you got that benefit on the contribution at the state level. So here in Indiana when this federal rule came out in the Secure Act 2.0, we were all we had a feeling, but we were all anxiously waiting to see well what’s Indiana going to say now that federally you’re allowed to transfer money from a 529 plan to a Roth with no penalty and no tax. Is Indiana going to say, “Yeah, that tax credit free and clear.” or are they going to say, “Listen, for that extra tax credit that you got, you’re going to have to pay that back if you do this maneuver.” And yeah, it didn’t take them too long. just a few months into that new rule being out there, they said, “Yeah, this is a this is going to be subject to credit recapture,” which is their way of saying if you got a credit a state tax credit on those dollars and then you transfer them from the 529 to the Roth, you’re going to have to repay that tax credit. Essentially, that’s Indiana saying, “We created this credit to incentivize you to save for for education, and if you end up using it for something other than education, then our agreement upfront wasn’t legit, it wasn’t honored, so we’re going to claw back those those dollars.” Moving money from a 529 plan to a Roth, that is a federal rule, not a state rule. So, you have to check with your state on whether or not they’re going to allow that to um not violate any of those tax goodies we were talking about earlier, right? And I would not call this a a pitfall. I would call it a potential surprise as in well I didn’t know it worked that way because and as we’ve talked wait a minute if I do a 529 plan contribution and I get a credit Indiana the state of Indiana’s giving me back some of my money that I paid but they’re letting me keep money that I ordinarily wouldn’t be able to keep. So, I’m keeping this money and at some point in the future, if I don’t use it for its intended purpose, I might have to give some money back to them. And if you told me today, hey, I could have some money and I could use it for a number of years and some at some point in the future I have to give it back to you, I probably I’d probably still take the money. But but the other thing to think about, and this is not an unusual situation where we used to use the Virginia College Savings Plan, it had American funds in it. Um, a lot of uh a lot of folks that work with Edward Jones use the Virginia College Saving Plan or did. And so a lot of folks that had a a 529 plan before 2007 when this became a deal in Indiana and the pot got really sweet have that money. So let that be part of the decision-making process when your kids are going to college. which plan, which state plan do I pull the money out of first? Because if you burn through the Indiana money first, and then you want to make these changes with the Virginia College Savings Plan, you’re not going to get spanked on the way out. Yep. Okay. So, you took that in a in a direction that I wasn’t expecting. Essentially saying, if you have 529 plans in multiple states, make sure you’re drawing off of the right state’s plan in the right order. Another way to think about that is it’s possible that for any given student out there, there might be multiple 529 plans that are set up by multiple owners. Uh, think parents opening an account and funding it for their kids education. Maybe grandparents were doing the exact same thing. You might get to a point, we’ve had clients where the student themselves, they’re working through high school and they save some money into a 529 plan for themselves. the order that you draw out of those accounts could leave uh maybe some extra money left over at the end of the college years for using this strategy, but it could also mess you up from a financial aid standpoint because these three owners and the accounts are treated differently from a financial aid uh perspective. So, be be paying attention to that as well. This is why, you know, I don’t know if pitfalls or potential mistakes or surprises is the right phrase, but your certified financial planner is there to help you navigate the complexities of a strategy like this. Yeah. Surprises sounds better, but no one likes financial surprises. No way. No. And and considering that you got the tax credit, you know, 15, 20 years ago, it just seems punitive to back. Um, okay. So, Josh, you just touched on another one that was on my list of of pitfalls, mistakes. I’m going to say this could fall in surprise as well, and it’s not coordinating between parents and grandparents. I think one of the biggest risks with this is grandparents looking at their resources and saying, “Well, we’re not going to spend all this money in our lifetime.” And um you know, we want to we want to help the next generation get a head start or or be set up for success. And therefore, yes, let’s contribute to this 529 plan for these grandkids. But what are the challenges? Don’t know how many grandkids we’re going to have. we’ve got, you know, they they had multiple kids and therefore their kids have multiple kids. Therefore, you’ve got potentially a lot of different grandkids, five, six, eight, nine, 10, you know, that sort of thing. And just saying, well, let’s keep it simple. I’ll just have one five plan and then divvy it up later. That is actually the advice that we would give for a lot of people, especially right before before this rule changed. Now, you want to make sure that you’ve got that you meet that 15-year rule. And so, therefore, grandparents, you might need to add a little bit more complexity to your financial life by having a 529 plan for each grandchild. But then secondarily, you’d probably need to start that communication with the parents, with your kids to say, “Wait a second. Are you guys funding 529 plan? We are too. Wait a second. Is all this money going to be used for college or do we think some dollars could be used for the Roth? Therefore, where does it make sense to do that from? Yeah. If a grandparent was intentionally funding a 529 plan to overfund it and have money left over for this strategy that that this episode has been all about moving money from a 529 plan to a Roth after the college years have passed. You have to be communicating that good intention because my observation, I don’t know what if you guys have seen, but often when uh parents know that the grandparents are helping to fund college, it often allows them or leads them to like ease off the throttle a little bit on their own contributions. It’s almost like, well, the grandparents are the base and then we’re gonna supplement on top of that instead of the reverse uh responsibilities. And so I just making sure that the right intentions are being coordinated I I think is it requires great um communication. Right. Yeah. Um another one I think that is a common mistake this is just sort of violating some of the rules that we talked about but not being aware of that of that income requirement to make this transfer. And so Kevin and I were kind of throwing stones a little bit in the first segment because well doing this transfer from 529 to Roth means that person also can’t contribute out of their own pocket or out of their paycheck even to the Roth IRA if it’s being funded by the 529 plan. So being aware of that you can’t double dip. You can’t do both in the same year. I don’t see that as a big problem because likely right out of college if you’re if you’ve got earned income then you probably have a 401k that you can be sheltering money into. So I’d almost say hey child contribute as much as you can to the 401k through work and we’ll use the 59 plan to fund your Roth for the first 5 years. Yeah, this creates an interesting conundrum which almost demands co generational coordination. That’s what I was going to say as well. So missing that coordination could be an enormous mistake as well. There’s others, but but really understanding the rules and understanding if this creative proactive planning strategy makes sense for you. You got to work with your certified financial planner on that. That’s all the time we have for today on behalf of Josh Gregory, Kevin Korhorn, all of us at KFG. Have a great weekend. We’ll see you next Saturday for the Wise Money Show with Korhorn Financial Group. Securities offered through Silver Oak Securities member FINRA/SIPC. Advisory services offered through KFG Wealth Management LLC. Join business as Korhorn Financial Group. KFG Wealth Management LLC and Silver Oak Securities Incorporated companies are unaffiliated.
