New 529 Rules: Rollover to a Roth IRA

A 529 plan is a tax-advantaged savings account designed to help families set aside funds for future education costs. Contributions can grow federally tax-deferred, and withdrawals are tax-free when used for qualified education expenses. For years, a concern for account holders was the consequence of leftover funds if a child did not pursue higher education, as non-qualified withdrawals of earnings are subject to income tax and a 10% penalty.

The SECURE 2.0 Act, signed into law at the end of 2022, has changed the landscape for overfunded 529 plans by providing a new avenue for unused savings.

The 529 to Roth IRA Rollover Provision

Beginning in 2024, a provision within the SECURE 2.0 Act permits unused funds in a 529 plan to be moved into a Roth Individual Retirement Account (IRA). This change directly addresses the issue of over-saving for education. The primary advantage of this rollover is that it allows funds to be repurposed for the beneficiary’s retirement, avoiding the income tax and 10% penalty on the earnings portion of a non-qualified withdrawal.

By converting leftover college funds into retirement assets, the money retains its tax-advantaged status within the Roth IRA, where it can continue to grow tax-free.

Eligibility Requirements for the Rollover

Several conditions must be met before a rollover from a 529 plan to a Roth IRA can occur. These prerequisites are designed to ensure the provision is used as intended.

• The 529 account must have been open for a minimum of 15 years. This long-term holding period is intended to prevent the 529 plan from being used as a short-term shelter to funnel money into a Roth IRA.
• The rollover must be directed to a Roth IRA owned by the designated beneficiary of the 529 plan. The funds cannot be transferred to the Roth IRA of the account owner, unless the owner and beneficiary are the same person.
• Any contributions made to the 529 plan within the five-year period preceding the rollover, along with any earnings on those contributions, are ineligible for the transfer. This “look-back” rule prevents last-minute contributions from being immediately rolled over.
• The beneficiary must have earned income. The amount of the rollover in a given year cannot exceed the beneficiary’s earned income for that year, up to the annual IRA contribution limit. All IRA contributions require the account holder to have compensation.

Rollover Limits and Financial Rules

There are specific financial limits that govern how much money can be moved from a 529 plan to a Roth IRA.

The amount that can be rolled over in any single year is subject to the annual Roth IRA contribution limit. For 2024, this limit is $7,000 for individuals under age 50. This annual cap is inclusive of all IRA contributions. If a beneficiary has already contributed $2,000 to their Roth IRA in a given year, they can only roll over an additional $5,000 from their 529 plan for that same year.

In addition to the annual limit, there is a lifetime maximum of $35,000 that can be rolled over from a 529 plan to a Roth IRA for any single beneficiary. This is a cumulative cap. Once a beneficiary has received a total of $35,000 in rollovers, they are no longer eligible for this provision, regardless of how much money remains in the 529 account.

How to Execute the Rollover

The process of executing the rollover involves coordination between your 529 plan administrator and the Roth IRA custodian. The first step is to contact the administrator of your 529 plan to inquire about their specific procedures and request the necessary paperwork to authorize a rollover.

Simultaneously, you should contact the financial institution that holds the beneficiary’s Roth IRA. It is important to confirm that they are able to accept an incoming rollover from a 529 plan and to understand their specific requirements for the transaction.

The recommended method for moving the funds is through a direct trustee-to-trustee transfer. In this process, the 529 plan administrator sends the money directly to the Roth IRA custodian. This method is preferable for tax reporting and minimizes the risk of error, ensuring the funds are properly designated as a rollover.