Some families are concerned about saving too much in a 529 plan and not being able to remove excess funds without incurring a penalty. The SECURE 2.0 Act, which became law in December 2022, changes the 529 plan rules to permit rollovers of some funds from these college savings accounts into a Roth IRA. It could allow transfers to take place without tax and penalty fees. The new rule will impact parents and their children as they face educational expenses and commit to long-term saving.
Rollovers from 529 plans to Roth IRAs are only permitted if certain criteria are met including:
— 529 plan beneficiaries can roll over up to $35,000 to a Roth IRA over their lifetime.
— Rollovers are subject to Roth IRA annual contribution limits.
— The 529 account must be more than 15 years old.
— 529 to Roth IRA rollovers can be made beginning in 2024.
[See: 10 Reasons to Save for Retirement in a Roth IRA.]
Can You Roll Over a 529 to a Roth IRA?
Under the SECURE 2.0 Act, starting in 2024, you will be able to roll over a 529 plan to a Roth IRA if you meet certain criteria. “The 529 account must have been open for at least 15 years,” says Danny Cieniewicz, a financial planner who focuses on education planning for parents of high school teens in Shillington, Pennsylvania.
If you have only recently opened the 529 plan, you’ll need to wait to reach the 15-year threshold before rolling over funds to a Roth IRA.
There is a lifetime rollover limit of $35,000. In addition, the rules indicate that funds contributed to the 529 account within the five years preceding the rollover will not be eligible to roll over.
How to Roll Over a 529 to a Roth IRA
If you are eligible to make the rollover from a 529 plan to a Roth IRA, you’ll need to check with the custodian of the 529 account. “If you have a 529 plan at a custodian that also has the ability to hold both a 529 plan and a Roth IRA, it is likely to be a seamless transition and you should be able to transfer everything over internally,” Cieniewicz says. “You would just want to make sure you can set both accounts up and can do an internal rollover.”
In cases in which the custodian who oversees your 529 plan cannot hold a Roth IRA in addition to a 529 plan, you may need to take a 529 plan withdrawal and then make a contribution to the Roth IRA. “You’ll need to make sure you have these moves documented in the event of an IRS audit, so a 1099-Q will be generated if funds are distributed from a 529 plan, and the Form 5498 will be received from the Roth contributions,” Cieniewicz says.
[Read: How to Open a Roth IRA.]
When You Can Roll Over a 529 to a Roth IRA
Under the SECURE 2.0 Act, the new rules will become effective on Jan. 1, 2024. It’s possible that additional clarification on the rules will be provided before that date. These details could cover the $35,000 rollover limit, direct rollover logistics, the required 15-year holding period and the inability to transfer funds that are contributed within the last five years before the rollover.
For account holders who are concerned they won’t utilize the savings in a 529 plan, the change could bring relief. “Overfunded 529 accounts have concerned parents and grandparents for years,” says Eric Blattner, partner and wealth advisor at Divvi Wealth in North Kansas City, Missouri. “Until now, 529 plan assets had to be spent on qualified higher education expenses in order to avoid income tax and penalty.”
The new guidelines indicate that the Roth IRA will need to be established for the child’s benefit. In addition, “the Roth IRA account owner needs income,” Blattner says. The maximum amount that can be rolled over each year is $6,500 for 2023 or earned income, whichever is less. If the child earns $2,000 from a job, the maximum amount that can be rolled over is $2,000.
[See: How to Pay Less Tax on Retirement Account Withdrawals.]
How to Start Planning Your 529 Rollover Now
If you have 529 funds that you anticipate won’t be used for education, you may be thinking about rolling them over to a Roth IRA. You might talk to your financial advisor or custodian regarding your options. You could also consider other ways that 529 funds can be applied.
While the new rules create more options for 529 funds, these accounts already had some layers of flexibility built into them. “Under current rules, if 529 funds are not utilized by the named beneficiary for any reason, those funds can remain invested with no tax or other consequences for use at a future time by the named beneficiary,” says Patricia Roberts, chief operating officer at Gift of College, based in New York. “What’s great is that contributions will continue to grow tax-free and can be used at a later day for many different forms of education.” These include undergraduate and graduate studies, along with trade and technical school.
For account holders, this could mean there’s less need to worry if students take a gap year or change their mind regarding whether to pursue higher levels of education. If the beneficiary does not use the funds, they can be transferred to a 529 plan account of the beneficiary’s family member without any tax or penalty. “The recipient could be a sibling, step-sibling, parent, aunt, uncle, grandparent, cousin or even a child of the original beneficiary,” Roberts says. “If you are the parent of the beneficiary, you can even use the funds for your own adult learning.”
In addition, if the 529 plan beneficiary receives a scholarship, the amount up to the value of the scholarship can be taken out without charges. The same is true if the beneficiary receives other educational assistance or goes to a military academy. “Tax would simply be owed on the earnings portion of the withdrawal, since tax was not paid on those earnings while the account was growing in value within the 529 college plans,” Roberts says.
More from U.S. News
What Is the Roth IRA 5-Year Rule?
How to Roll Over Funds From a 529 College Savings Plan to a Roth IRA originally appeared on usnews.com