How to Transfer a 529 Plan to a Roth IRA

A recent change in federal law created a new financial planning opportunity for individuals with college savings accounts. The SECURE 2.0 Act, effective January 1, 2024, allows for tax-free rollovers from a 529 education savings plan to a Roth Individual Retirement Account (IRA). This provides an option for repurposing leftover 529 funds for retirement savings without incurring federal taxes or penalties. This transfer is subject to a specific set of rules and limitations.

Eligibility Requirements for the Transfer

Several conditions must be met before a rollover from a 529 plan to a Roth IRA can occur. The primary requirement is that the 529 account must have been maintained for at least 15 years. If the designated beneficiary on the 529 plan is changed, this 15-year clock restarts from the date of the change.

Another condition is that the Roth IRA designated to receive the funds must be owned by the same individual who is the beneficiary of the 529 plan. The rollover cannot be directed to a Roth IRA belonging to the 529 account owner or any other person. This ensures the funds continue to benefit the individual for whom the educational savings were originally intended.

A time-based restriction applies to the funds being moved. Any contributions made to the 529 account within the last five years, and any earnings on those contributions, are not eligible for the rollover. This rule is designed to prevent using the 529 plan as a short-term pass-through vehicle to fund a Roth IRA.

Finally, the beneficiary of the 529 plan must have earned income during the tax year of the rollover that is at least equal to the amount of the rollover. For example, to roll over $7,000, the beneficiary must have at least $7,000 in compensation. The standard income limitations that restrict who can contribute to a Roth IRA are waived for these specific rollovers.

Understanding the Transfer Limits

The amount of money that can be moved from a 529 plan to a Roth IRA is governed by two limits. The first is an annual cap tied to the Roth IRA contribution limits set by the IRS for that year. This annual limit is $7,000 for individuals under age 50 and $8,000 for those age 50 and older.

This annual rollover amount is integrated with the beneficiary’s overall ability to contribute to an IRA. Any amount rolled over from the 529 plan directly reduces the amount the beneficiary can contribute to a Roth or traditional IRA for that same tax year. For instance, if a beneficiary rolls over $4,000 from a 529 plan, they can only contribute an additional $3,000 to their IRA for that year, assuming the $7,000 annual limit.

The second constraint is a lifetime maximum. An individual beneficiary can only roll over a total of $35,000 from all 529 plans into their Roth IRA over their lifetime. This is a cumulative cap, and once the beneficiary has reached the $35,000 lifetime limit, no further rollovers are permitted.

The Rollover Process Step-by-Step

Initiating the transfer of funds from a 529 plan to a Roth IRA involves coordinating between two financial institutions. First, contact the administrator of the 529 plan, which could be an investment firm or a state-sponsored program manager. You should inquire about their specific procedures and paperwork for processing a rollover under the SECURE 2.0 Act.

Simultaneously, communicate with the financial institution that holds the Roth IRA, often referred to as the custodian. Inform the custodian that you intend to receive a direct rollover from a 529 plan. They will provide guidance on their requirements to accept the incoming funds and may have specific forms to complete.

The most effective method for the transfer is a trustee-to-trustee transfer. This involves instructing the 529 plan administrator to send the funds directly to the Roth IRA custodian. This direct movement helps ensure the transaction is correctly reported and avoids potential complications from the beneficiary taking temporary possession of the funds.

Tax and Reporting Considerations

When all eligibility rules and transfer limits are followed, the rollover from a 529 plan to a Roth IRA is free from federal income tax and the 10% early withdrawal penalty. The transaction moves assets from one tax-advantaged account to another without triggering a taxable event at the federal level.

A point of caution involves state tax laws. The federal rules allowing for tax-free rollovers may not be recognized by all states, as some tax codes may not conform to this provision of the SECURE 2.0 Act. In such cases, the state might treat the rollover as a non-qualified withdrawal. This could trigger state income tax on the earnings portion of the distribution and potentially require the recapture of any state tax deductions previously claimed. You should verify the tax treatment in your specific state.

After the rollover is completed, you will receive tax forms from both financial institutions. The 529 plan administrator will issue a Form 1099-Q, and the Roth IRA custodian will issue Form 5498, which will report the amount received as a rollover contribution.