New Rules Allow Rollover of Funds From 529 Plan to Roth IRA

There’s good news for families who diligently save for their child’s education with a 529 plan. Thanks to legislation passed in 2022, this popular savings vehicle just got more flexible. Starting in 2024, unused funds from a 529 plan can be rolled over into a Roth IRA.

Let’s dig into the details.

Understanding the 529 College Savings Plan

First, let's recap what a 529 plan is. A 529 plan is a tax-advantaged savings account for future education costs. A 529 plan offers various investment options and allows for tax-free withdrawals when the funds are used for qualified education expenses, such as tuition, fees, books, and room and board. These accounts also offer an easy way for friends and family to contribute to a child’s college fund.

However, some parents are reluctant to participate in a 529 plan because of unknown variables:

• What if my child gets scholarships and doesn’t need all the money we saved in a 529 plan?

• What if my child decides to not go to college?

• What happens if there are left over funds after my child graduates?

While there are already options for left over funds, the Secure 2.0 Act opened a door to an appealing new option for parents who are on the fence about opening a 529 plan.

Secure 2.0 Act Makes 529 Plans More Versatile

Thanks to the Secure 2.0 Act, which focuses on enhancing retirement and savings for families, you can roll over funds from a 529 educational savings plan to the beneficiary's Roth IRA starting January 1, 2024.

This change is a gamechanger for parents who were previously reluctant to participate in a 529 plan due to the concerns noted above.

Eligibility & Limits

Before you rush to roll over any unused 529 funds to a Roth IRA, it's important to note that there are limits to this provision.

The legislation stipulates a maximum dollar amount that can be rolled over from a 529 plan to a Roth IRA. Families should be mindful of these limits to ensure compliance with the law. Here are the highlights of what you need to consider:

• The 529 plan must be open for at least 15 years

• The Roth IRA must be in the name of the beneficiary of the 529 plan (i.e., the student)

• The rollover has a lifetime limit of $35,000 per beneficiary

• The rollover is subject to the annual IRA contribution limit

For example, the IRA contribution limit for 2024 is $7,000. If the beneficiary contributed $3,000 to another IRA, only $4,000 remains available for the 529 rollover for that year.

Considering the annual contribution limit, it would take a minimum of five years to reach the rollover lifetime limit of $35,000.

• Contributions made in the last five years to a 529 plan are not eligible to be rolled over to a Roth IRA.

Tax Planning Considerations

Many parents open a 529 plan when their child is born to allow time for the funds to grow tax-free. However, there are tax planning considerations to be aware of before contributing funds.  

1. Contributions to a 529 plan are after-tax contributions, which means they are not tax deductible for federal purposes. However, many states have their own 529 plans and allow contributions to be deducted for state income purposes. There is an annual deduction limit that varies from state to state. For example, in Maryland, you can deduct up to $2,500 per account holder per beneficiary annually.  

2. Although 529 plans don’t have annual contribution limits, states typically put a cap on the total accumulated funds per beneficiary, ranging from $300,000 - $500,000. That being said, it is still important to be aware of gift tax reporting. The annual gift exclusion for a taxpayer in 2023 is $17,000 ($34,000 per couple).

3. Another great option for grandparents who wish to contribute to a 529 plan is super funding. This allows a single contribution in one year that is equal to up to five years’ worth of the annual gift tax exclusion to a 529 without tax consequences. As such, a grandparent could contribute $85,000 (5 x $17,000) in 2023 . While there is no tax consequence with super funding, you are required to file a Gift Tax Return, Form 709.

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