Can You Switch 529 Plans? Here’s How

A 529 plan is a tax-advantaged savings vehicle for future education expenses. Contributions grow tax-deferred, and qualified withdrawals for educational costs are tax-free. Many wonder if they can switch plans. It is possible to switch 529 plans, allowing account holders to adapt their college savings strategy.

Understanding 529 Plan Rollovers

A 529 plan rollover transfers funds from one 529 plan to another. The Internal Revenue Service (IRS) permits tax-free rollovers under certain conditions. A key rule is one tax-free rollover per beneficiary within a 12-month period. This means only one rollover for a given beneficiary can occur within a 12-month timeframe across all accounts.

Funds can be rolled over tax-free to a new 529 plan for the original beneficiary or a qualified family member. The IRS broadly defines a qualified family member, which includes:
Spouse
Children (including stepchildren, adopted children, and foster children)
Siblings (including stepsiblings)
Parents (including stepparents)
Aunts
Uncles
Niece
Nephews
First cousins

This flexibility allows families to reallocate funds if the original beneficiary’s educational path changes or if funds remain after their education.

Reasons to Consider a 529 Plan Change

Several factors might prompt switching a 529 plan. One motivation is seeking better investment performance or more investment options. Plans typically offer various investment strategies, such as age-based portfolios that automatically adjust asset allocation over time, static portfolios with fixed allocations, or individual portfolios allowing more direct control over underlying funds. Evaluating a plan’s historical performance and investment choices can influence a decision to move funds.

Another reason involves reducing fees and expenses. 529 plans may charge annual maintenance fees, which can range from $10 to $50 per year, and administration or management fees, sometimes up to 0.70% of assets. Underlying fund expenses, known as expense ratios, also vary, with industry averages around 0.48% and some plans offering options as low as 0.14%. Switching to a plan with lower costs can allow more savings to grow for educational purposes.

Account owners might also consider a rollover if they move to a new state. While 529 plans can be used for qualified expenses at eligible educational institutions nationwide, some states offer tax deductions or credits for contributions made to their specific in-state plans. Transferring funds to a plan in a new state could unlock state-specific tax benefits for future contributions. Dissatisfaction with customer service or administrative features can also be a reason to seek a new provider.

Changing the beneficiary is a frequent reason for a rollover, especially if the original beneficiary receives a scholarship, chooses not to pursue higher education, or has leftover funds. If the new beneficiary is a qualified family member, the change can be made without tax implications. This offers flexibility, ensuring funds can continue to benefit a family member’s educational journey.

Executing a 529 Plan Rollover

Initiating a 529 plan rollover requires careful attention to detail to ensure a smooth, tax-free transfer of funds. Before beginning the process, the plan owner should gather essential information from both the existing 529 plan and the new target plan. This includes account numbers, beneficiary details, and specific investment option codes for the new plan where the funds will be allocated. The new plan provider will typically supply the necessary forms for incoming rollovers.

There are two primary methods for executing a 529 plan rollover: a direct rollover or an indirect rollover. A direct rollover is the most straightforward approach. In this method, the account owner completes a rollover request form provided by the new 529 plan administrator, who then works directly with the old plan provider to transfer the funds. This “trustee-to-trustee” transfer minimizes the account owner’s direct involvement in handling the funds.

An indirect rollover involves the funds being distributed directly to the account owner from the original 529 plan. The account owner then has a strict 60-day window to deposit these funds into the new 529 plan to maintain the tax-free status of the rollover. If this 60-day deadline is missed, the distribution will be considered non-qualified, leading to potential income tax and penalties. Account holders choosing the indirect method must closely monitor this timeframe.

Avoiding Common Rollover Issues

Failing to adhere to 529 plan rollover rules can lead to financial consequences. A common pitfall is violating the “one-rollover-per-12-months” rule. If additional rollovers occur within this period, the distribution is considered non-qualified. This results in the earnings portion of the distribution being subject to federal income tax and an additional 10% federal penalty tax. Some states may also impose income taxes or recapture previously claimed deductions.

Another issue arises if the new beneficiary is not a qualified family member. In such cases, the distribution is also deemed non-qualified. Similar to violating the 12-month rule, this triggers income tax on the earnings and a 10% federal penalty. Understanding the IRS definition of a qualified family member is important to avoid these adverse tax implications.

For those undertaking an indirect rollover, missing the 60-day deadline to redeposit funds is an error. If the funds are not transferred within this timeframe, the entire distribution becomes non-qualified. Consequently, the earnings are subject to ordinary income tax and the 10% federal penalty. Diligent tracking of this deadline is necessary to prevent financial repercussions.