529 Plan Rollover to Roth IRA: Maximize Your Savings

Starting January 1, 2024, 529 plan account holders can now roll over funds into Roth IRA retirement accounts without incurring taxes or penalties, though there are some restrictions. This update has alleviated concerns for many families about unused or excess funds in their 529 accounts.

These modifications are part of Section 126 of the SECURE 2.0 Act, included in the Consolidated Appropriations Act of 2023 (CAA), which was enacted in December 2022. However, the rollover provisions only took effect in 2024. Here’s what you need to know.

529 plans have long been a favored vehicle for saving for education, offering tax advantages to help families manage the rising costs of college and other qualified educational expenses. However, the recent legislative changes have introduced a new, exciting option for these savings plans: the ability to roll over unused 529 plan funds into a Roth IRA. This option can be particularly advantageous for individuals with leftover funds in their 529 plans after completing their education. In this article, we’ll delve into the details of this rollover option, including benefits and potential drawbacks.

Understanding 529 Plan and Roth IRA

Imagine your 529 plan as a storage room full of valuable items that are no longer needed. Instead of letting them collect dust, you can move them to a new room where they continue to add value to your home. This is exactly what rolling over your 529 plan to a Roth IRA does for your finances. A 529 plan is designed for education savings, growing your funds tax-free to help cover college costs.

On the other hand, a Roth IRA is a retirement account where your investments grow tax-free, and withdrawals in retirement are also tax-free.

How to Rollover Funds From a 529 Plan to a Roth IRA

Beneficiaries of a 529 plan can now transfer a lifetime maximum of $35,000 from a 529 plan to a Roth IRA without facing taxes or penalties.To do so, participants must follow a few key eligibility rules for rolling over a 529 plan to a Roth IRA, including:

• The 529 account must have been open for more than 15 years.
• The eligible rollover amount must have been in the 529 account for at least 5 years.
• The annual rollover limit is subject to Roth IRA annual contribution limits ($7,000 in 2024; those age 50 and older can contribute an additional $1,000).
• Rollovers can only be made to the Roth IRA account owned by the named 529 account beneficiary.
• Roth IRA income limits do not apply for this type of contribution.

Step-by-Step Rollover Process

1. Verify that your 529 plan has been open for at least 15 years.
2. Ensure that the funds you intend to roll over have been in the account for at least 5 years.
3. Determine the annual contribution limits for the Roth IRA.
4. Initiate the rollover to the Roth IRA account owned by the 529 plan beneficiary.
5. Confirm the rollover with both the 529 plan provider and the Roth IRA custodian.

How Much Can I Convert or Rollover from a 529 Plan to a Roth IRA? – Rollover Limits

To illustrate, let’s say you have $50,000 left in your 529 plan after your child graduates. You can roll over up to $35,000 over several years, respecting the annual contribution limits. For example, in 2024, you could roll over $7,000. In subsequent years, you can continue to roll over $7,000 annually until you reach the $35,000 lifetime cap.

What to Watch Out for When Converting a 529 Plan to a Roth IRA

When considering this rollover, be mindful of the following potential pitfalls:

• Ensure the account has been open for at least 15 years.
• Verify the funds meet the 5-year rule.
• Understand the annual rollover limits and plan accordingly.
• Remember that only the beneficiary’s Roth IRA can receive the rollover.

Pros and Cons of Converting a 529 to a Roth IRA

Pros

• Tax-Free Growth: Both accounts offer tax-free growth, making the rollover process seamless from a tax perspective.
• Flexibility: Provides an option for unused educational funds, turning them into retirement savings.
• Penalty-Free: Avoids the 10% penalty typically associated with non-qualified 529 plan withdrawals.

Cons:

• Limitations: The lifetime rollover limit of $35,000 may not cover all unused funds.
• Time Restrictions: Accounts must meet the 15-year and 5-year requirements, which could limit eligibility for some.

Tax Implications and Benefits of Rolling Over a 529 Plan to a Roth IRA

Can I Make a Tax-Free Rollover from a 529 Account to a Roth IRA?

Yes, the rollover can be made tax-free, provided all conditions are met. This offers a significant advantage as it allows the funds to continue growing tax-free in the Roth IRA, and future withdrawals in retirement will also be tax-free.

What If My State Doesn’t Conform to the Federal Rule for 529-to-Roth Rollovers?

State tax laws may vary. Some states might not conform to federal rules regarding tax-free rollovers. Check with your state tax authority to understand any state-specific tax implications or benefits.

Should You Choose a 529 Plan with No State Tax Deduction?

If you live in a state that does not offer a state tax deduction for 529 contributions or if the state does not conform to federal rollover rules, consider whether the tax benefits of the Roth IRA might outweigh the state tax deduction for 529 contributions. This could make 529 plans from states with no tax deduction more attractive if you plan to use the rollover option.

Rolling over a 529 plan to a Roth IRA presents a unique opportunity to maximize the value of your education savings by converting them into a powerful retirement tool. By understanding the rules, limits, and benefits, you can make an informed decision that secures both your child’s education and your financial future.