Coming in 2024: Roll Your 529 Plan Over to a Roth IRA
By Joe Messinger, CFP®
October 27, 2023
Raise your hand if you (or your kids) have untouched money left in an old 529 Plan after you graduated college. Good problem to have by the way!
This is an all-too-common problem that the SECURE Act 2.0 is looking to resolve. Under new rulings, people can roll over “leftover” funds in their 529 Plan to a Roth IRA. Let’s look at what this means for you – and how you can leverage this new opportunity for your finances.
The new rule for 529 Plan funds is:
If you have funds in a 529 Plan, but no longer need them for qualifying education expenses, you can roll those funds over to a Roth IRA with a lifetime limit of $35,000. Prior to this new rule, individuals with a 529 Plan would be taxed (at their standard tax rate) on the withdrawals from their plan after graduating – and they may have had to pay an additional penalty fee for using the funds for non-qualifying expenses (10% on any earnings associated with each distribution).
Benefits of the New Rule
529 Plan participants with excess funds in a 529 now have an exciting opportunity to take advantage of:
- SECURE 2.0 provides that beginning in 2024, beneficiaries of 529 plans may transfer unused funds directly to a Roth IRA without penalties or recognition of taxable income.
- They’re permitted to roll over the full Roth IRA annual contribution limit ($6,500 in 2023) each year until the lifetime cap of $35,000 is reached.
- This allows 529 Plan participants to leverage funds in their account for expenses beyond their secondary education.
Rules you need to Know about a 529-to-Roth IRA Rollover
Transferring and contributing funds to a Roth IRA comes with significant restrictions and rules. The new 529 to Roth IRA transfer is no different. The rules you need to know about this particular rollover are:
- Ownership Rule: The Roth IRA must be in the name of the beneficiary of the 529 plan.
- Income Rule: The income limit is waived for a 529 to Roth IRA Rollover
- Five-Year Rule: Rollover amounts cannot include any amounts contributed to the 529 plan (as well as any earnings on those contributions) in the preceding five-year period.
- 15-Year Rule: The 529 plan must have been open for a minimum of 15 years prior to the rollover. It is unclear as of the date of this article whether this 15-year period restarts when there is a beneficiary change, or if you transfer from one 529 plan to another in the 15 year window.
- Lifetime Limit Rule: $35,000 lifetime cap on rollovers per beneficiary
- Roth IRA Annual Contribution Limit Rule: The annual limit on the rollover is the IRA contribution limit for the year, less any other IRA contributions. For example: if you made a $2,000 contribution to your Roth IRA, you would only be allowed to transfer $4,500 so as to not exceed the $6,500 annual contribution limit.
The New Rule In Action
Let’s say you’re currently in your mid 30’s and your parents have informed you that there is $32,000 still left in your old 529 Plan. You’ve considered removing the funds from the account, or even changing the name on the account to be one of your (future) children for college savings. However, you’re not sure what your parenthood timeline is, and saving for retirement is also a concern for you. You might opt to roll $6,500 of your 529 Plan into a Roth IRA every year until the funds have all been transferred over the course of 5 or 6 years.
This would allow you to continually boost your retirement savings in a tax-efficient way, skip any hefty penalty fees that come with withdrawing from your 529 Plan in a traditional way, and you can still opt to have the account owner change the “beneficiary” of the account to a future child if that comes into play down the line.
It is common for 529 funds to be invested in what is frequently referred to as an “age based portfolio”. They are popular because of the hands off design. An age-based portfolio in a 529 plan involves adjusting the investment mix within the plan based on the beneficiary’s age and the number of years until they plan to use the funds for qualified education expenses. These portfolios are designed to become more conservative as the beneficiary gets closer to college age to reduce the risk of losing principal. In most age based portfolios your allocation will be very little into equities and almost all cash and fixed income from the age of 16 and beyond. Any funds remaining will stay invested extremely conservatively unless you make a change. So, if you have made this decision to consider these funds earmarked for retirement, make sure to revisit your risk tolerance given the new time horizon and allocate your funds appropriately in the 529 as you carry out the staged transfer of these assets over the coming years.
Wondering if rolling over an old 529 Plan to a Roth IRA would be beneficial to your financial strategy? We’re here to help. Schedule a consultation with us here to talk through questions you have, and if you want to incorporate Roth accounts into your retirement savings strategy.
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