Good News: Rolling College Savings Balances Into IRAs

Written by Rob Copeland | 27 February 2024

Tax-advantaged college-savings plans known as 529 plans have gotten very popular since their introduction in 1996. But while their tax benefits are attractive, a question has hung over them: What happens to the funds that aren't spent?

There's now a new answer to that question, and in my view it makes 529 plans a lot more attractive. Under the SECURE 2.0 Act of 2022, as much as $35,000 can be rolled from a 529 into a beneficiary's Roth IRA account. It's true that college costs continue to rise far faster than the general rate of inflation. But even so, it's not uncommon for beneficiaries to use only part of their 529 funds for college, graduate school or trade school.

They may get scholarships, may end up going to a less-expensive school than they'd planned, or might skip college altogether. However they wind up with leftover 529 funds, these beneficiaries can now use that money to jumpstart their retirement savings in a Roth IRA. By starting young, they can use the power of compounding over several decades to build a big chunk of what they'll need to retire.

Before the SECURE 2.0 Act, leftover 529 funds could be saved in case the beneficiary wound up with more education expenses, or could be transferred to a family member's 529 plan. Any other withdrawals of the money resulted in an income tax and a 10% federal tax on earnings. Now, 529-account owners or beneficiaries can roll $35,000 into a Roth IRA with the same beneficiary over their lifetime. The catch is that it has to be done in increments; the annual rollover limit is the same as the yearly IRA contribution limit. For 2024 it's $7,000. Starting at age 59 ½, principal and earnings in the Roth can be withdrawn tax-free.

Here's an example of how 529-plan money can be turned into retirement nest-egg money. Say a 529-plan beneficiary has $35,000 left if the account after completing their education. They start rolling $7,000 a year into a Roth. Assuming they earn 8% a year in the IRA, They'll have a total of $51,778.76 after five years in that account. Now let's say they're age 29 when that process ends, and that they intend to retire at age 65. That's 36 years of compounding, after which, at an 8% return, they've have $922,114.21 of tax-free retirement funds. The power of compounding over time would ensure the beneficiary winds up with nearly $1 million toward retirement.

As always, there are caveats. One big one is that the 529 account being rolled into a Roth IRA has to have been open for at least 15 years. Contributions made less than five years ago aren't eligible, and neither are their earnings. And remember that $7,000 is the total IRA contribution limit for this year, including whatever amount you move from a 529 to a Roth. So if you've contributed $2,000 to a Roth since the start of the year, your 529 rollover total for the year can only be $5,000.

The new rollover rules, and the age-old power of compounding make contributing to 529 plans a lot more attractive than they used to be. Please reach out to us if you'd like to learn more.

How to Invest This Election Year

Written by Rob Copeland | 19 January 2024

Investors often worry about poor stock returns during election years, and that's not surprising, given the idea that markets dislike uncertainty. But while election years are often volatile, the truth is that over the years has tended to be good.

Between 1937 and 2022, for example, the S&P 500 index has posted an average annual return of 9.9% during presidential election years. You can rest assured that emotions will be in full swing as the November election approaches. But where your investment portfolio is concerned, it's important to be calm and rational, to minimize your risk and be ready to seize opportunities.

In presidential election years, the market volatility tends to be front-loaded into the first half of the year. That's when candidates, campaigning in the primaries, tend to make extreme policy proposals. It doesn't matter that they'd likely never become law: The point is to appeal to voters on the far ends of the political spectrum who play an outsized role in selecting presidential candidates.

By the time the general-election campaign is in swing, the rhetoric has typically calmed down a bit, and markets start to gain some traction. Opportunities to invest will present themselves throughout the year.

But first, it's important to evaluate the risk in your portfolio. That's because the large-cap stocks that carried 2023's big returns, including the big rally at the end of the year, will likely cool off.

If you've owned any of the "Magnificent 7" stocks over the past year or two—Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla and Meta Platforms—those stocks could be seriously overweighted in your portfolio right now. And given their inflated prices, they could do a nosedive during the periods of volatility and set you back significantly.

In my view, small- and mid-cap stocks are poised to have a strong year. They were largely overlooked last year, and broadly speaking they're priced attractively. Furthermore, smaller-cap stocks tend to benefit strongly from falling interest rates, and it's widely believed that the Federal Reserve is done raising rates and will start cutting them in 2024.

As for new investments, there's plenty of opportunity, and many companies could become more efficient and profitable thanks to the widening adoption of artificial intelligence. I believe AI could spur the next growth wave of corporate profits. As always, we want to wait for an attractive price before buying any stock. In the meantime, you might want to park your cash in three-months Treasury bills, which are currently yielding an attractive 5.45%.

Don't hesitate to reach out to us if you'd like to review the risk level of your investment portfolio and identify the stocks that could power your portfolio for the coming year.

How to Protect Your Heirs from Strict New IRA Rules

Written by Rob Copeland | 20 December 2023

Every piece of legislation that's passed in Washington creates both winners and losers. If you're planning to leave an IRA to your kids, you may be one of the losers in the case of the SECURE Act.

Passed in 2019 and taking effect in 2020, the SECURE Act, was aimed at boosting retirement savings—a worthy goal at a time when too few people are saving enough for their later years. But it also killed what were known as stretch IRAs, creating serious consequences for heirs. The SECURE Act didn't ban stretch IRAs for everyone; exceptions exist for spouses, minors, and some disabled individuals. But plenty of families have been affected by the law, and many more will be in the future.

Stretch IRAs, also known as multigenerational IRAs, were an estate planning strategy that allowed the original owner's beneficiaries to inherit a traditional, tax-deferred IRA and take annual required minimum distributions (RMDs) based on their own life expectancy, not the original owner's. RMDs are just what they sound like: The government wants taxes to be paid, and for taxes to be paid, withdrawals must be made. So it requires chunks of money to be withdrawn every year starting at age 73. The stretch strategy was so valuable because it prolonged the tax-deferred growth of the account, often for decades, while limiting the taxes due every year.

Now that stretch IRAs are gone, most non-spouse inheritors must withdraw the entire IRA balance within 10 years. This speeds up tax revenue for the government, but it also means bigger tax bills and less time for IRA money to grow. Adding to the tax pain for heirs is the fact that adult children are often in their peak earning years—and thus in higher tax brackets—at the time they receive an inheritance.

One way that IRA owners can help their heirs out is by converting their traditional IRA to a Roth IRA. The funds in Roth IRAs grow tax-free, and are withdrawn tax-free. Converting an IRA to a Roth does trigger a tax bill, so it's necessary to have cash available to pay it; alternatively, some opt to convert their IRA over two years, thus splitting up the tax hit. The Roth conversion strategy has proven quite popular as a fallback in the wake of the SECURE Act. That testifies to the fact that even with the tax bill, families that make use of it are likely to come out way ahead.

Please don't hesitate to get in touch with us if you'd like to learn more about transferring wealth to the next generation tax-free.

Tax-Loss Selling is Losing its Luster

Written by Rob Copeland | 21 November 2023

The end of the year is in sight, and soon countless investors will start selling losing stocks in order to gain tax writeoffs. The practice, known as tax-loss harvesting or tax-loss selling, is extremely popular because it's essentially free money: Stocks (or bonds in some cases) are sold at a loss in order to offset the capital-gains tax bill created when winners are sold. The result is that your tax bill is slashed and you keep more of your money in your pocket.

For years, I've recommended and executed tax-loss selling for my clients, just as the vast majority of financial advisors have. But I plan to be more selective this year and won't sell positions that I like purely for the tax benefit. I'll harvest tax losses where it makes sense; for example with positions that I've lost confidence in. But I think the long-term potential for stocks I believe in outweighs the attractiveness of short-term tax savings.

A big reason I'm less enamored of tax-loss selling has to do with changes in market behavior. Traditionally, the massive year-end selling to harvest tax losses has led to lower security prices. Once the new year begins, the names that sold off in December—and are now cheap—have become buying targets. If investors purchase them soon enough, the continuing buying demand pushes up these stocks' prices to pre-selloff levels and nets a quick profit. That's known as the January effect.

Unfortunately, this strategy has become a victim of its own popularity. These days, the stocks that sold off in December are snapped up incredibly fast in January—often with the help of automated buying programs. The buying pressure drives up prices so quickly that it's become very hard to find them "on sale."

Compounding the problem is the "wash-sale rule." It prevents investors from claiming a loss on the sale of a security if a substantially identical security is repurchased within 30 days. The fact that you can't buy back the same security you've sold for 30 days means that, too often, you're waiting to make the trade while watching the price creep up a little further every day. Thus, the rationale for selling good stocks just for tax purposes has gotten a lot weaker.

If the goal is to maximize your wealth over the long term—and almost all investors should be focused on the long term rather than quick profits—then it's best to be very judicious about tax-loss harvesting. If a holding just doesn't seem like it will work out, then selling it for a tax advantage can definitely make sense. But holding those you believe in makes more sense than ever.