529 Plan to Roth IRA Rollovers
General
A 529 College Savings Plan can be a useful investment tool for tax-advantaged education funding; however, certain 529 investors face issues when withdrawing funds from their account due to overfunding or the account beneficiary not finishing/attending college. In the past, 529 withdrawals not used on qualified education expenses would incur a 10% penalty and any investment gains would be subject to federal income taxation. But, due to a new provision in the SECURE Act 2.0, this is no longer the case. Starting in 2024, unused 529 funds can be rolled into a Roth IRA; eligible accounts can rollover up to a lifetime limit of $35,000 from a 529 Plan to a Roth IRA. By understanding the eligibility requirements and transfer rules, 529 holders can utilize excess funds to bolster their beneficiary’s retirement nest egg while avoiding tax liability and penalties.
Eligibility Requirements
Secure Act 2.0 defines the criteria for 529 accounts eligible for the Roth Rollover:
- 529 Plan must have been opened and held for the same beneficiary for at least 15 years.
- The listed beneficiary on the 529 Plan must be the owner of the Roth IRA that is receiving the funds. Rollover process is only possible if the 529 beneficiary matches the Roth IRA owner.
- Contributions are expected to be based off the beneficiary’s earned income in the calendar year. The IRS ruling for those with no earned income is unclear, and it’s still undecided if ‘sufficient income’ will be part of 529 rollover eligibility. This is an important consideration to monitor; usually, those with no earned income cannot make Roth contributions. Those with an earned income of $1 - $6,999 in the calendar year can contribute an amount equal to their earned income, while anyone earning $7,000 or more can contribute up to the limit of $7,000 in 2024.
- A key difference from standard Roth contributions is that Modified Adjusted Gross Income (MAGI) limits do not apply here; an eligible beneficiary earning more than the max income limit in the calendar year ($153,000+ if filing single) can still contribute up to the $7,000 limit.
- Contribution amount will be affected if the beneficiary has already made IRA and/or Roth IRA contributions during the same calendar year. (Example: if a beneficiary who’s eligible for the $7,000 max rollover already made a $1,000 IRA contribution in 2024, their max possible rollover value from 529 to Roth in the year is $6,000).
Transfer Rules
Guidelines for the 529 Asset Rollover Process:
- Provision went into place December 31st, 2023. Rollovers from 529 Plan to Roth IRA are eligible on January 1st, 2024.
- $35,000 lifetime rollover limit per beneficiary.
- To reach the $35,000 lifetime rollover limit, transfers will have to be executed across multiple years.
- The contribution being rolled from 529 to Roth in each specific year must be held in the 529 account for at least 5 years prior to transfer date. (Example: A 529 contribution made in 2024 can be rolled over starting in 2029).
- Rollover must be plan-to-plan or trustee-to-trustee, cannot write a check from 529 Plan and deposit to Roth IRA.
Conclusion
Sweeping changes enacted by the SECURE Act 2.0, including the 529 Plan to Roth IRA rollover, are expected to enhance the retirement savings of millions of Americans. The rollover option allows the younger generation (beneficiary) to capture more value from their leftover 529 Plan contributions, while the older generation (grantor) can take a tax-advantaged opportunity to transition their education funding into a more useful investment for the future. However, the new 529 Plan to Roth rollover is best used as a backup option for excess 529 funds; it should not be treated as a primary retirement savings strategy. The rollover should only be considered by eligible individuals who have already fully funded their qualified education expenses; ensure the 529 Plan is first achieving its primary purpose. The IRS may adjust or clarify this legislation in the future, so those interested in this process should check with their financial advisor or tax professional before taking action. Sources | Fidelity, Charles Schwab, Journal of Accountancy
We have gathered this information from sources we believe to be reliable. It is intended to provide a general summary and not meant to be legal advice. If you have any questions, please contact Creative Financial Group.
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