April 18, 2024
New for 529 Plans – Rolling Unused Education Savings into a Roth IRA
Many variables go into estimating costs and saving for education, and, between scholarships, grants and alternative options, the amount saved usually does not match perfectly with the total paid. As of January 1, 2024, a federal statute known as SECURE 2.0 allows you to give the beneficiary of a 529, such as your child or grandchild, a strong start on retirement savings by rolling up to $35,000 of unused 529 funds tax-free into a Roth IRA. Several rules apply to this new option, and here we outline the primary details you will want to understand.
SECURE 2.0 is the second “Setting Every Community Up for Retirement Act.” Although the federal statute was signed into law in December 2022, the Roth IRA rollover just became effective this year. Before SECURE 2.0, the tax-free planning options for assets remaining in a 529 after college stayed within the education realm. Those options include changing the beneficiary to another family member and rolling a 529 to a 529A if the beneficiary is disabled. Also, the first SECURE Act from 2019 allows 529 distributions of up to $10,000 per borrower to be used to repay qualified student debt. Otherwise, income tax and a 10% penalty are assessed on the earnings portion of a 529 distribution that is not used for qualified education expenses.
The new 529 to Roth IRA rollover option transitions a tax advantaged education savings asset into a tax advantaged retirement asset. Before implementing a 529 to Roth IRA rollover as a financial planning strategy, remember that 529 accounts and Roth IRAs are distinct types of tax advantaged assets.
Section 529 is part of the Internal Revenue Code (IRC), and it sets the rules for distributions that qualify as tax-free for education expenses. Each state offers its own 529 plan with different types of investments and fund managers. The owner of a 529 is usually a parent or grandparent of the asset’s beneficiary.
The IRC also governs Roth IRAs. Eligibility to contribute to a Roth IRA depends on an individual’s modified adjusted gross income (MAGI) and tax filing status. Withdrawals are qualified, i.e. income tax and penalty free, if: (1) the distribution occurs at least 5 years after the owner first funded a Roth IRA; and (2) the distribution occurs after the account owner reaches age 59 ½. (There are other exceptions to the second requirement including the account owner’s disability or death, and a withdrawal of up to $10,000 for a first-time home purchase.)
As a planning strategy, the 529 to Roth IRA rollover has several specific details and because it is new, there are gray areas that the Internal Revenue Service (IRS) needs to clarify. Below we highlight specific rules and outline certain qualifications that you should discuss with your tax advisor.
Specific rules
- The owner of the Roth IRA must be the 529 beneficiary. This means that although a parent or grandparent may own the 529, they cannot be the owner of the Roth IRA.
- The 529 account must have been open for at least 15 years. Check with your tax advisor about the specifics of this requirement if the account beneficiary has been changed within the last 15 years.
- Contributions to the 529 account and earnings on the contributions made within the preceding 5 years are not eligible for the rollover.
- The beneficiary must have earned income at least equal to the amount of the rollover. The rollover serves as the beneficiary’s Roth IRA contribution for that year. The beneficiary cannot complete a rollover and make a separate contribution to a traditional or Roth IRA. Also, the rules for 529 to Roth IRA rollovers are distinct from those governing Roth IRA contributions. A high earning beneficiary who cannot contribute to a Roth IRA because their MAGI is too high can still complete the 529 rollover.
- Rollovers are subject to the annual Roth contribution limits. In 2024, the annual maximum is $7,000 with a $1,000 catch-up contribution for individuals aged 50 and older. A lump sum rollover of $35,000 is prohibited. The rollover must be a series completed over several years. The deadline for the rollover is the annual tax filing deadline.
- The lifetime maximum rollover amount is $35,000 per beneficiary. This amount is currently not indexed for inflation.
Remember that early Roth savings increase retirement security. So, although there are several rules related to the rollover, talk with your tax advisor and financial planner to learn whether you are eligible for this new strategy. With SECURE 2.0’s new 529 to Roth IRA rollover, the bridge from tax advantaged education savings into tax advantaged retirement savings is open.
Anna Hays
Senior Wealth Management Officer
Anna Hays is an attorney, Certified Financial Planner (CFP®) and Senior Wealth Management Officer with Cape Cod 5. She has over 25 years of experience developing estate and trust plans that integrate financial goals.
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