529-To-Roth IRA Rollovers: What You Need To Know
Americans saving up for college with a 529 plan will get a little extra help in 2024 thanks to a new rule that allows unused funds in a 529 account to be rolled into a Roth IRA without incurring any taxes. The rule is part of the Secure 2.0 Act and aims to give families more flexibility with unused 529 money.
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Table of Contents
What Is a 529 Plan?
A 529 plan is a college savings plan that provides tax advantages when used for qualifying purposes, similar to a Roth IRA or 401(k), except the money is used for education rather than retirement.
Contributions to a 529 are not deductible on federal tax returns, but earnings are allowed to grow tax-free, and distributions for qualifying educational expenses are also tax-free. Many states allow a tax deduction or tax credit for residents using an in-state 529 plan.
Can You Rollover Funds from a 529 Plan to a Roth IRA?
Although this wasn’t allowed in the past, you can now roll over unused funds from a 529 plan to a Roth IRA.
When Do You Qualify For A Rollover?
If the beneficiary of the plan ends up spending less on college due to scholarships or simply choosing another career path, you’ll have to find a way to deal with the 529 funds. Although you can spend the funds on other eligible family members, a rollover into a Roth IRA is another option.
The new opportunity does come with some restrictions. Here’s what you need to know:
The 529 account must have been open for at least 15 years.
The eligible rollover amount must have been in the 529 account for at least five years prior to the rollover date.
The funds must be rolled over to a Roth IRA owned by the 529 account beneficiary.
There’s a $35,000 lifetime cap on Roth IRA rollovers for each 529 account beneficiary.
Rollovers are subject to applicable Roth IRA annual contribution limits.
With these rules, you likely don’t want to overfund your 529 by too much. It’s possible to roll the funds from your 529 to a Roth IRA. But the limitations could make it a somewhat slow process.
How Much Can You Rollover?
You can rollover a total of $35,000 during your lifetime form a 529 to a Roth IRA. But the rollovers you make each year cannot exceed the annual contribution limits attached to Roth IRAs.
Benefits of 529-to-Roth IRA Rollover
The new rule letting 529 planholders move unused funds into a Roth IRA was greeted with enthusiasm by most financial experts because of the additional options it provides families.
“This new provision addresses a common concern we’ve heard for years from families worried about what happens if their student doesn’t go to college,” Mary Morris, CEO of Virginia529 and chair of the College Savings Plans Network, said in a press release. “Although 529 accounts are flexible — and qualified uses have expanded in recent years to include K-12 tuition and certain student loan repayments, among other options — the Roth IRA rollover is one more way to support the long-term dreams and financial wellness of families.”
A recent blog on the Charles Schwab website had a similar take, noting that the new provision gives savers another way to put their 529 assets to work.
What To Consider With a 529-to-Roth IRA Rollover
A question raised in the Schwab blog post is whether investors might see the new rule as a way to intentionally overfund a 529 with the aim of eventually building up a tax-free Roth account. But that’s not likely to be the case, according to Chris Kawashima, a senior research analyst at the Schwab Center for Financial Research.
“This provision offers another option for those wondering what to do with unused 529 assets,” he said. “Funding a Roth isn’t the primary selling point.”
As Virginia529 noted, you don’t necessarily have to wait to roll funds over to a Roth IRA. You could also transfer the 529 account to another qualifying family member such as a spouse, son or daughter, sibling, parent, niece, nephew or in-law.
It’s usually not a good idea to intentionally overfund your 529 plan in order to funnel the funds into a Roth IRA. If your goal is saving for retirement, then consider contributing directly to a Roth IRA.
Tax Effects of Rollovers
If you make the rollover through a trustee-to-trustee transfer and stick within the limits, you won’t face a tax penalty when you make this switch.
How To Roll Over Funds From 529 Plan to Roth IRA
If you want to rollover funds from a 529 plan to a Roth IRA, here are the steps to follow.
Open a Roth IRA. The owner of the Roth IRA must be the beneficiary of the 529 plan. For example, if your child is the 529 plan beneficiary, then you’ll need to help them open a Roth IRA.
Confirm eligibility. You can only rollover up to the annual contribution limit for a Roth IRA or up to the amount of earned income the beneficiary made in a year. For example, if your child made $5,000, then you can only rollover $5,000 to the Roth IRA that year.
Set up the trustee-to-trustee transfer. You can work with your brokerage platform that holds the 529 plan to set up a trustee-to-trustee transfer to avoid any unnecessary tax penalties.
Tips for a Smooth Transfer
As you navigate this process, make sure to have an eye for details. Although it’s possible to move the funds, you’ll need to meet a wide range of eligibility requirements and ensure the transfer is done in a trustee-to-trustee style. If you aren’t sure about any of the steps, consider working with a financial professional to sort out the details.
Other Ways to Save For College
A 529 plan isn’t the only way to pay for college. Below are some other strategies to help you cover college costs.
Savings account. You could tuck your funds into a high-yield savings account as your child prepares for college. This is especially useful if your child will go to college in the near term.
Taxable brokerage accounts. While you give up tax advantages, you can build a nest egg in a taxable brokerage account to use for anything, including college costs.
Prepaid plans. Some states offer prepaid college tuition plans, which allows you to pay for college well before your child heads to campus.
Final Take
A 529 plan offers a useful way to save for college. But if you end up oversaving in this account, rolling the funds into a Roth IRA is one option. You could also use the funds for a qualified family member’s college costs, paying down some of your own student loans, or simply withdrawing the funds and taking a tax hit.
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FAQ
You have questions about 529 to Roth IRA rollovers. We have answers.
Can I convert my 529 to a Roth IRA?
Yes, you can roll the unused funds from a 529 into a Roth IRA. But the rollover must come from a 529 account that has been open for at least 15 years and the funds cannot exceed the Roth IRA's annual contribution limits.
What is the 15-year rule for 529 plans?
If you want to roll funds from a 529 plan into your Roth IRA, the 529 account must have been open for at least 15 years. You'll need to wait until your 529 plan hits its 15th birthday before attempting to roll over the funds.
What happens to money in a 529 if not used?
You can leave the funds in your 529 account to use for other qualified family members, including grandchildren. You can also roll over the funds into a Roth IRA, use up to $10,000 of the funds to pay off student loans, or withdraw the funds for a non-qualified expense and face a tax penalty.
Can you withdraw 529 contributions without penalty?
Yes, you can withdraw 529 contributions without a penalty if you are using the funds for a qualified education expense.
Sarah Sharkey contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: 529-To-Roth IRA Rollovers: What You Need To Know
