Rolling Over 529 Plan Assets to a Roth IRA

Planning for a child’s education often involves setting aside significant funds in a 529 plan. These plans are highly beneficial due to their tax advantages when used for qualifying educational expenses. However, many families face a dilemma when their child finishes their education with leftover funds in the 529 plan. This changed with the introduction of the Secure 2.0 Act, which provides a new, favorable option for rolling over 529 plan assets to a Roth IRA.

What to Do with Unused 529 Plan Assets?

Until recently, there were only a few options available when the beneficiary of an IRC Sec. 529 qualified tuition plan (QTP) finished his or her education, with assets remaining in the plan.

1. Beneficiary change: The owner of the account could change the beneficiary of the account. To be federally income-tax free, the new beneficiary must be a qualifying member of the original beneficiary’s family. Distributions for the new beneficiary will continue to be federally income-tax free¹ if they are made for qualifying higher education expenses.

2. Education loans: Up to $10,000 (total) may be distributed tax-free in repayment of principal or interest on any qualified education loan of the beneficiary or a sibling of the beneficiary.

3. Pay the taxes: A beneficiary may distribute amounts from QTP, with the earnings portion subject to ordinary income tax, plus a 10% income tax penalty.

Secure 2.0 Act – Rollover of 529 Plan Assets to a Roth IRA

The Secure 2.0 Act, part of the Consolidated Appropriations Act, was signed into law by President Biden on December 29, 2022. One part of this new law contained a provision, effective in 2024, allowing for a federally tax-free transfer of funds from a QTP to a Roth IRA in the name of the QTP’s designated beneficiary. To qualify for this tax-free transfer treatment, a number of complex requirements must be carefully followed:

• 529 plan in existence for at least 15 years: The QTP must have been in existence for at least 15 years before a transfer to a Roth is made.

• Five year “cooling off” period: No distribution is allowed of contributions (and earnings on those contributions) made during the 5-year period immediately preceding a distribution.

• Trustee to trustee: A QTP to Roth IRA transfer must be done on a direct trustee-to-trustee basis.

• Lifetime dollar limit: No more than $35,000 (lifetime total) may be transferred from the QTP to the Roth IRA.

• Annual contribution limits: Each year, a QTP to Roth IRA transfer is limited to the regular, annual contribution limits applicable to individual retirement accounts. For 2024, for a taxpayer under age 50, this limit is $7,000. For a taxpayer aged 50 or older, the limit is $8,000. Further, if the beneficiary also separately contributes to an individual retirement account, that separate contribution will reduce the amount that may be transferred from the QTP to a Roth IRA.

• Earned income requirement: In the year of transfer, a beneficiary must have earned income at least equal to both the amount distributed from the QTP to the Roth IRA, as well as any separate contributions.

• Upper income limits do not apply: Regular contributions to a Roth IRA are subject to certain phase-out limitations applicable to higher-income taxpayers. The phase-out limits do not apply to a QTP to a Roth IRA transfer.

Seek Professional Guidance

Given the complex nature of the rules applicable to this new provision of federal tax law, with the potential for a significant tax burden if the law is not followed correctly, the advice and guidance of trained, experienced tax professionals is strongly recommended.

Conclusion

The new rollover option from 529 plans to Roth IRAs offers families a flexible and tax-advantaged way to repurpose leftover education savings. By understanding and adhering to the detailed requirements of the Secure 2.0 Act, families can make the most of their education savings plans and continue to build a strong financial future. Proper planning and professional advice are key to leveraging this new opportunity and achieving long-term financial goals.

¹ These limits are subject to adjustment for inflation each year.

- Article posted on 7/17/24 -

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

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