How to Roll Over Leftover 529 Money to a Roth IRA

A 529 plan is a tax-advantaged savings account designed to help families set aside funds for future education costs. A Roth IRA is an individual retirement account where contributions are made with after-tax dollars, allowing for tax-free withdrawals in retirement. The SECURE 2.0 Act introduced a provision allowing for tax-free rollovers from 529 plans to Roth IRAs, effective January 1, 2024.

This legislative update offers a solution for those with leftover money in a 529 account, whether due to scholarships or other circumstances. It allows these savings to be repurposed for the beneficiary’s retirement without the typical tax consequences of a non-educational withdrawal. However, this opportunity has specific rules that must be followed.

Eligibility and Rollover Conditions

To take advantage of the 529 to Roth IRA rollover, several conditions must be met. The 529 plan must have been open and maintained for a minimum of 15 years before a rollover is permitted. It is important to note that some interpretations suggest changing the designated beneficiary on the account could restart this 15-year clock.

The individual who is the named beneficiary of the 529 plan must also be the owner of the Roth IRA that will receive the funds. The money cannot be rolled into a Roth IRA for the account owner or another family member; it must directly benefit the person for whom the education funds were originally saved.

A rule involves the timing of contributions. Any contributions made to the 529 plan within the five-year period leading up to the rollover are ineligible for transfer. This restriction also applies to any earnings generated from those recent contributions. For example, if a rollover is initiated on July 1, 2025, any money deposited into the account after July 1, 2020, cannot be included.

The rollover is treated as an annual contribution to the beneficiary’s Roth IRA, which means the beneficiary must have earned income. The amount of the rollover in a given year cannot exceed the beneficiary’s compensation for that year. While the SECURE 2.0 Act waives adjusted gross income (AGI) limitations, the earned income requirement remains in place.

Rollover Limits and Financial Implications

There is a lifetime maximum of $35,000 that can be moved from a 529 plan to a Roth IRA for any single beneficiary. This is a cumulative total over the beneficiary’s life. Once this $35,000 cap is reached, no further rollovers from any 529 plan are permitted for that individual.

In addition to the lifetime cap, there is an annual restriction on the amount that can be rolled over. The sum moved in any single year cannot be more than the annual Roth IRA contribution limit for that year. For 2024 and 2025, this limit is $7,000 for individuals under age 50 and $8,000 for those 50 and older.

The amount rolled over from the 529 plan directly reduces the beneficiary’s ability to make separate contributions to their Roth IRA for that year. For example, if the annual contribution limit is $7,000 and the beneficiary rolls over $4,000 from a 529 plan, they are only permitted to contribute an additional $3,000 of their own money to their Roth IRA for that tax year.

Assuming all eligibility conditions are met, the rollover transaction is free from federal income tax and the 10% early withdrawal penalty. However, state tax implications can differ. Some states might treat the rollover as a non-qualified distribution, which could trigger state income tax and potentially the recapture of state tax deductions.

The Rollover Process

Initiating a 529 to Roth IRA rollover requires coordination between two separate financial institutions. The first step is to contact the administrator of the 529 plan. You will need to inquire about their specific procedures for processing a rollover to a Roth IRA, as each plan may have its own forms and requirements.

It is your responsibility to determine and document the eligibility of the funds, including tracking the account age and the amount of contributions eligible for the transfer. You must also communicate with the financial institution that holds the beneficiary’s Roth IRA. It is necessary to confirm that they can accept a direct rollover from a 529 plan and to understand their requirements.

The actual transfer of funds is handled as a direct, trustee-to-trustee transaction. This means the 529 plan administrator will send the money directly to the Roth IRA custodian without the funds passing through the account owner or beneficiary. This method is preferred as it ensures clear documentation for tax purposes.

Other Permitted Uses for Remaining 529 Funds

If a rollover to a Roth IRA is not a suitable option, there are several other permitted uses for leftover 529 plan funds that avoid negative tax consequences.

• Change the beneficiary of the account. The funds can be transferred to another qualifying family member, such as a sibling or grandchild, to be used for their own educational pursuits.
• Pay for K-12 tuition. Account owners can withdraw up to $10,000 per year, per beneficiary, to pay for tuition at an elementary or secondary school.
• Repay qualified student loans. A lifetime limit of $10,000 per individual can be withdrawn from a 529 plan to make payments on principal or interest for a qualified education loan.
• Take a non-qualified withdrawal. In this scenario, the portion of the withdrawal that consists of earnings will be subject to ordinary income tax and a 10% federal tax penalty.