CONSIDERING A 529 PLAN TO ROTH IRA ROLLOVER?
Thanks to a change in the federal tax law that went into effect January 1, 2024, you may be able to roll 529 Plan savings into a Roth IRA without triggering income taxes or penalties. This guide is designed to help you identify those key decision points that may be important to you when considering whether a 529 Plan to Roth IRA is right for you. Of course, you should always consult your personal tax advisor for specific advice for your tax situation.
Q. What is a 529 Plan?
A. 529 Plans, also known as qualified tuition plans, are state-sponsored, tax-advantaged savings accounts that offer tax-free withdrawals and other benefits when used to pay for qualified education expenses for a designated beneficiary. Using 529 Plan funds for anything other than qualified education expenses can result in taxes and penalties, which is why a Roth IRA rollover may be advantageous (especially, where the 529 Plan beneficiary and their family members do not have any qualified education expenses).
A full list of qualified education expenses can be found in the Internal Revenue Service’s Publication 970, Tax Benefits for Education.
Q. How does a 529 Plan work?
A. In a 529 Plan, an account owner (which could be a parent, grandparent, or any other
individual) establishes the account for a designated beneficiary. The account owner controls the account’s investments and the ability to make withdrawals. The account owner also generally is able to change the account’s beneficiary at any time, including for situation where if the beneficiary does not attend college or does not need the funds for education. If the beneficiary is changed to another member of the beneficiary’s family; this can be done tax-free.
Q. What is a Roth IRA?
A. A Roth IRA is a retirement savings account that allows the IRA owner to save for retirement and take tax-free distributions from the account at retirement so long as (1) the distribution occurs more than 5 years after setting up a Roth IRA, and (2) the IRA owner has reached age 59 ½. A Roth IRA differs from a traditional IRA, because with a traditional IRA, taxes on earnings are deferred until distributions from the account are taken at the time of retirement, but in a Roth IRA, qualifying distributions from the Roth IRA are entirely tax-free.
Q. What is a 529 Plan to Roth IRA rollover?
A. As of January 1, 2024, a 529 Plan account owner can rollover qualifying 529 Plan assets—up to a lifetime maximum of $35,000—to a Roth IRA in the name of the 529 Plan account beneficiary without incurring the usual 10% penalty for nonqualified withdrawals or generating any taxable income. This preserves tax-free savings if the 529 Plan beneficiary does not need to use all of the funds for education-related tuition or expenses.
Q. Who is eligible for a 529 Plan to Roth IRA rollover?
A. There are several eligibility requirements and limitations on a 529 Plan to Roth IRA rollover. Many of the limitations are designed to make sure that this type of rollover is used only for excess 529 Plan funds and is not a means to get around Roth IRA contribution limitations.
- The 529 Plan account must have existed for at least 15 years (we are awaiting clarification from IRS as to whether changing the beneficiary affects the 15-year clock).
- Contributions made to the 529 Plan within the last 5 years are not eligible to be rolled.
- Rollovers must be made to the 529 Plan account’s designated beneficiary’s Roth IRA.
Q. What are the benefits of rolling savings from a 529 Plan to the Beneficiary’s Roth IRA?
A. For those who have accumulated excess savings in a 529 Plan account, the 529 Plan to Roth IRA rollover allows for continued tax-advantaged savings. The beneficiary not only gets a head start on saving for education but can use any excess savings for retirement. These funds can be used even if the income of the Roth IRA owner/529 Plan beneficiary exceeds the income ceiling for annual Roth IRA contributions (in 2024, single filers with income above $161,000, and married couples filing jointly with income above $240,000 are not able to make an annual contribution to a Roth IRA).
Q. How much can I roll over to a Roth IRA from a 529 Plan?
A. In addition to the eligibility requirements above, there are a few other limitations on your ability to roll over from a 529 Plan to the beneficiary’s Roth IRA:
There is a lifetime rollover cap of $35,000 applicable to the 529 Plan owner for each 529 Plan beneficiary (we are awaiting clarification from IRS on how to apply this cap).
All 529 Plan to Roth IRA rollovers are subject to the Roth IRA annual contribution limits ($7,000 for 2024). In addition, if the Roth IRA owner has made an annual contribution to an IRA, those amounts will also count against their annual IRA contribution limit.
You can only roll over amounts equal to or less than the amount that the Roth IRA owner (i.e., the Beneficiary) has earned in income for that year
Q. When can the IRA owner take money out of the Roth IRA?
A. Roth IRA owners can take money out of their Roth IRA whenever they choose, but the tax impact is very different depending on their age and the length of time the owner has maintained a Roth IRA. Distributions are tax-free after the Roth IRA owner has reached age 59 ½ and has maintained a Roth IRA for at least 5 years. Distributions before age 59 ½ may be subject to taxes and penalties on earnings, but contribution amounts are tax and penalty-free.
Q. If I want to roll my excess 529 Plan funds into a Roth IRA, what’s next?
A. Complete your 529 carrier’s rollover distribution form in order to complete an excess 529 Plan funds rollover to a Roth IRA, which can only be done via a direct trustee-to-trustee transfer. It is important to not take a distribution from the 529 Plan with the intent to put it into the beneficiary’s Roth IRA within 60 days or some other time frame, as this renders the funds ineligible for the rollover.