Beginning January 1, 2024, a significant change under the SECURE 2.0 Act allows for eligible 529 funds to be rolled over tax and penalty-free from 529 plans to Roth IRAs owned by the beneficiary.
Previously, withdrawing 529 funds for non-educational purposes meant facing income tax and a 10% penalty on the earnings portion.
Subject to certain limitations, this change offers families a new avenue for unused education savings. These changes were included in Section 126 of the SECURE 2.0 Act, part of the Consolidated Appropriations Act of 2023 (CAA) signed into law in December 2022, but the rollover provisions only went into effect in 2024.
Here’s what you need to know -
Key Limitations:
Account Age: The 529 account must have been open for at least 15 years.
Contribution Age: Funds must have been in the 529 account for at least five years.
Annual Limit: Rollovers are subject to annual Roth IRA contribution limits ($7,000 for 2024, $8,000 if age 50 or older).
Lifetime Limit: A maximum of $35,000 per beneficiary can be rolled over from a 529 to a Roth IRA.
Income Requirement: The beneficiary must have earned income at least equal to the amount rolled over.
Other Considerations:
State Tax Implications: Not all States treat rollovers as qualified expenses for State tax purposes. Check with your State's 529 plan or a tax advisor for potential State tax penalties.
Alternative Options: If rollovers aren't suitable, explore other options like keeping the funds in the 529 plan for graduate school or changing the beneficiary.
How to Rollover: Contact your Roth IRA provider and follow their instructions for initiating a rollover.
There are still some grey areas in the statute that are subject to different interpretations, and for which the 529 plan industry is awaiting further clarification and guidance. However, most 529 plans have begun processing rollover requests.
How Much Can Be Rolled Over?
The rollover amount from a 529 plan into a Roth IRA account will be subject to the Roth IRA annual contribution limits set by the IRS. The annual Roth IRA contribution limit for 2024 is $7,000 ($8,000 for age 50 and older).
As mentioned above, there’s a $35,000 lifetime limit per beneficiary for 529 plan rollover contributions to Roth IRAs. You can’t transfer all $35,000 at one time; you can only transfer up to the annual limit each year.
For example - if you have $16,500 in your account, you could transfer $6,500 for the 2023 tax year (you have until Tax Day 2024 to make a 2023 contribution), $7,000 in 2024, and the remaining $3,000 in 2025. Tax and penalty-free transfers can only be made, though, if you meet the requirements outlined below.
What Other Rules Apply to 529 Plan Roth IRA Rollovers?
Funds cannot be moved from a 529 plan into a Roth IRA without incurring penalties and taxes unless the account has existed for at least 15 years. Changing designated beneficiaries also will likely restart that 15-year clock.
Accountholders and beneficiaries cannot roll over any contributions or earnings on contributions made in the last five years. In other words, the money transferred must have been in the account for at least five years, and the amount can’t exceed your balance from five years prior.
While Roth IRA contributions are subject to annual limits, when rolling over from a 529, they’re not subject to the typical Roth IRA income limits. This means those with incomes exceeding Roth IRA income limits can contribute to a Roth IRA by rolling over unused funds from a 529 plan when they’d otherwise be ineligible to contribute.
Does it Make Sense to Convert 529 Funds to a Roth IRA Now?
Moving leftover 529 funds to a beneficiary’s Roth IRA can be a great way to help them build their retirement savings. However, there may not be a reason to rush to do so yet.
In addition to unclear guidance to 529 plan managers on rules for these transfers, it’s not yet clear if all States will treat these rollovers as a qualified expense for State income tax purposes. Not all States follow the federal definition of qualified expenses for 529 plans, and in States that don’t, there could be State tax penalties caused by a 529 to Roth IRA rollover. Some States will need to update their laws to include these rollovers as a qualified expense, others may choose not to do so.
You can find the status of your State in relation to whether or not it considers transfers to a Roth IRA a qualified expense on www.savingforcollege.com. Saving for College is monitoring this information and will update it regularly as new information is released. If your State does not consider 529 to Roth IRA rollovers a qualified expense, be sure you consult the plan or your tax advisor to understand what implications there may be for you.
Remember that you always have other options for leftover 529 funds:
1) Transfer the plan funds to another beneficiary.
2) Save the plan funds for your child’s future educational needs i.e. Graduate school, etc.
3) Use the money to make student loan payments.
4) Save the plan for a grandchild.
5) Take advantage of penalty-free scholarship withdrawals.
How to Move Funds From a 529 Plan to a Roth IRA
If you’re ready to move forward with a 529 to Roth IRA rollover, start by opening a Roth IRA account for the beneficiary if they don’t already have one. The beneficiary of the 529 plan must also be the owner of the Roth IRA account.
The Bottom Line
While some details are still being clarified, this new rollover option enhances the flexibility of 529 plans, providing a valuable way to utilize leftover funds for retirement savings. Consult your 529 plan to determine the best course of action for your individual situation.
Articles and Commentary
Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Tamalpais Asset Management’s (“TAM”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. TAM does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. TAM has obtained the information provided herein from various third-party sources believed to be reliable but such information is not guaranteed. Certain links on this site connect to other websites maintained by third parties over whom TAM has no control. TAM makes no representations as to the accuracy or any other aspect of information contained in other websites. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. TAM is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of TAM.
Comments