529 rollover to a Roth IRA

December 16, 2023

529 plans are investment accounts that allow families to save up for a beneficiary’s education. Due to new government regulations, 2024 will be a significant year for 529 plans. The regulation changes remove some of the biggest drawbacks of these plans, specifically in regards to conducting 529 to Roth IRA rollovers.

In this article, Rocco Pendola, Paul Curcio, & David Tony from CNN.com detail the rule changes to 529 plans and the affect they have on 529 to Roth IRA rollovers.

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Thanks to new government regulations, 2024 is a big year for 529 college savings plans. Federal law removes one of the biggest drawbacks of 529 plans, particularly if you want to conduct a 529 to Roth IRA rollover.

+ What is a 529 and a Roth IRA?

A 529 plan is an investment account that allows families to save for a beneficiary’s future education.

There are two main types of 529 plans:

• The more popular education savings plan is an investment account with tax advantages and, usually, a slate of exchange-traded or mutual fund portfolios to choose from.

• The prepaid tuition plan lets savers pay for college in advance, typically via lump sum payment, a multi-year payment plan or in fixed monthly installments.

Typically, states sponsor 529 plans. You can access 529 plan proceeds without paying federal taxes as long as you use the funds to cover qualified education expenses, including tuition, books and certain room and board costs. Most states, including California, do not charge state income tax on 529 plan distributions used to pay qualified education expenses.

Of course, this includes the nine states without an income tax. Some states, such as New York, offer state income tax deductions on 529 contributions and no state income tax on qualified withdrawals.

This calculator from Charles Schwab helps you determine your state’s 529 plan tax situation.

A Roth IRA is a retirement account that allows investors to contribute after-tax income, then withdraw those contributions, plus accumulated earnings, tax-free, usually at retirement.

The main difference between these accounts is that 529 plans are meant to help you save for education expenses and Roth IRAs are meant to help you save for retirement. That said, you can also use a Roth IRA to cover education expenses. You can always withdraw Roth IRA contributions tax-free, regardless of age or purpose. Withdrawal of Roth IRA earnings prior to age 59 1/2 or before the account has satisfied the five-year rule typically triggers income tax and a 10% penalty. However, an early withdrawal to pay for education expenses avoids the 10% penalty, but not income tax.

You may wonder: What happens if I don’t want or need to use 529 money for college?

In this case, it might make sense to consider a 529 conversion to a Roth IRA.

+ How to convert a 529 to a Roth IRA

To convert a 529 to a Roth IRA, you should contact the company you have or want to open your Roth IRA with.

The SECURE 2.0 Act, which became law in December 2022, makes it potentially more attractive to make a 529 to Roth IRA conversion starting in 2024.

As of 2024, the following rules apply to 529 plan rollovers to Roth IRAs:

• The 529 plan must be under the beneficiary’s name for a minimum of 15 years.

• Yearly conversions cannot exceed annual Roth IRA contribution limits.

• The lifetime 529 to Roth IRA rollover limit is $35,000.

• 529 plan contributions (including earnings accrued on those contributions) made in the last five years cannot be transferred to a Roth IRA.

• If the beneficiary makes any IRA contributions in a given year, the eligible 529 to Roth IRA rollover amount is reduced by the size of that contribution. For instance, if the beneficiary contributes $3,000 to an IRA in 2024, the eligible rollover amount decreases to $4,000, based on the 2024 total IRA contribution limit set by the IRS.

• The rollover must be direct (e.g., plan-to-plan or trustee-to-trustee). You cannot take a distribution — a check — from a 529 and send it to a Roth IRA.

This example from Fidelity Investments shows how a 529 to Roth IRA rollover might look.

Prior to these new rules, the options for using unspent 529 funds were limited, which often meant facing tax and penalty consequences.

+ Benefits of converting a 529 to a Roth IRA

The main benefit of converting a 529 to a Roth IRA is the flexibility.

Beginning in 2024, unused 529 plan funds can go towards something other than education, particularly retirement. By moving 529 money into a Roth IRA for your beneficiary, you can give them a head start on saving for retirement, plus a wider array of investment options than is typically available in a 529 college savings plan.

+ Potential drawbacks of converting a 529 to a Roth IRA

We have already covered some of the cons of a 529-to-Roth IRA conversion, including restrictions around account age and annual and lifetime limits.

In addition, you can’t roll the money you moved to a Roth IRA back to a 529 plan. And by taking money out of a 529 plan, you’ll interrupt the growth of your old 529 plan investments, restarting the process with the investment choices you make in your Roth IRA.

+ Tax implications of converting a 529 to a Roth IRA

As discussed, starting in 2024, there are no tax consequences of converting a 529 to a Roth IRA as long as you follow the rules set by the SECURE 2.0 Act. You no longer have to worry about paying taxes and penalties associated with liquidating a 529 college savings plan.

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AUTHORS:
Rocco Pendola, Paul Curcio, & David Tony
CNN.com

PHOTO:
LPETTET/iStock

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