Will 529s become retirement accounts?

http://www.savingforcollege.com/articles/will-529s-become-retirement-accounts

Financial Professional Content

A bill introduced into Congress last week would have families scrambling to open 529 accounts—not necessarily for college, but instead for retirement! What exactly is this proposal, and what are its chances for becoming law?

H.R. 4333, introduced by Rep. Lynn Jenkins (R-KS), has the usual wish-list items found in prior bills aimed at Code Section 529: adding computer technology to the list of qualified higher education expenses, and permitting up to four investment changes in a 529 account in a year.

In addition, the proposed legislation would allow account owners to avoid taxes and 10% penalty by "undoing" a 529 distribution if the beneficiary quits school and receives a refund of tuition or other qualified higher education expenses. The account owner would have 60 days following receipt of the school refund to redeposit the 529 money. Many families would appreciate this "fix" to an unanticipated problem.

But here's the real surprise in H.R. 4333: a provision permitting account owners to roll over up to $25,000 from a 529 plan to a Roth IRA. And it could go to a Roth IRA for either the account owner or the beneficiary! This should start the wheels turning in the mind of any good financial planner!

A couple of strings are attached to the 529-to-Roth rollover. One is that the rollover amount is limited to contributions made at least five years prior to the transfer along with the earnings on those contributions. The other is that the 529 account owner must have opened the account at least ten years prior.

But some strings are conspicuously missing, i.e. no income limits, and no requirements for earned income.

While the presumed intention of the provision—encouraging more Americans to save for college by reducing the "risk" of an overfunded 529 account—is admirable, I foresee significant roadblocks to adoption beyond the usual Washington gridlock.

No doubt some taxpayers, particularly those currently precluded from contributing to a Roth IRA by income limits and earned income requirements, will make contributions to a 529 plan with the intention of funding retirement and not college. If the negative tax revenue impact doesn't kill the bill's chances in Congress, the opportunity for such "abuse" probably will.

The idea of 529-to-Roth portability is a terrific one. However, it would make more sense, and be a lot simpler, to allow a 529 account owner to transfer money from a 529 account when making the annual contribution to his or her Roth IRA (or to a Roth IRA for the beneficiary). The rollover contribution would be subject to all the current Roth IRA requirements that involve earned income, income limits, and contribution limits.

I hope these concerns can be appropriately addressed and that the 529 portability concept survives.