529 plan to Roth IRA Distributions: What You Should Know

Feb. 22, 2023

A common concern savers have around 529 college savings plans is that they will over-save and not be able to use all the funds. Perhaps the beneficiary of the account decided to forego further education, they received a generous scholarship, or had other sources that covered their college tab. Recognizing this potential deterrent to saving and funding 529 plans, lawmakers created the ability to put all those savings towards the ultimate goal: retirement.

Passed within the Consolidated Appropriations Act 2023 late last year, SECURE Act 2.0 created the new ability to roll up to $35,000 from a 529 plan to a Roth IRA. But before you do, there are a number of details you need to know:

  1. Rollovers will be allowed beginning January 1, 2024.
  2. Any rollovers must come from a 529 plan account that has existed for at least 15 years. Like the Roth 5-year rule, this is a good reason for anyone to open a 529 plan today and contribute even just a small amount to get the clock started.
  3. Contributions within the last five years to the 529 plan are ineligible to be rolled over to a Roth IRA.
  4. The Roth IRA must be in the same name as the beneficiary of the 529 plan at the time of the rollover.
  5. You can only rollover up to the annual Roth IRA limit per year (i.e., $6,500 for those under 50, and $7,500 for those 50 and older in 2023). The annual limit will apply to rollovers AND contributions to all Roth IRAs of a beneficiary.
  6. There is an earned income requirement for the Roth IRA owner – they need to have earned at least the amount that is rolled over each year. However, there is no earnings limit like there are for regular Roth IRA contributions (i.e., $153,000 for single filers and $228,000 for married filing jointly filers in 2023).
  7. The lifetime maximum, per beneficiary, is $35,000.
  8. The rule appears to apply per beneficiary, so you can (potentially) change a 529 plan beneficiary to someone else and continue doing Roth IRA rollovers. However, further guidance from the IRS is needed so we recommend delaying this strategy until that time.

If you don’t check all the boxes above for a 529 plan to Roth IRA rollover, there are still many other uses for those leftover 529 plan funds:

  1. Change the beneficiary of the 529 plan to an eligible family member or yourself to use for further education at qualifying institutions. These can include colleges, universities, vocational (trade) or private K-12 schools.
  2. Along the same lines, if an eligible family member has any student loans, you can set them as the beneficiary of the account and use the funds to repay up to $10,000 worth of qualifying student loans.
  3. Treat the account as a “dynasty” 529 plan and save it for future generations’ education needs, allowing it to continue to grow tax-free.
  4. If a 529 plan beneficiary receives a scholarship, you can withdraw that amount penalty-free, however, you will likely owe income tax on any earnings (i.e., growth and interest). Most of the time, the withdrawal has to happen within a certain time of receiving the scholarship, typically the same year.
  5. If none of these solutions work, it’s not the end of the world for the beneficiary to simply take a non-qualified 529 plan withdrawal and use the funds for themselves. There will be a 10% penalty and income taxes on the earnings portion, along with potential state penalties and taxes, but when all the dust settles, the total will likely be in a similar spot compared to having the money in a taxable account all along.

The new 529 plan to Roth IRA rule creates greater flexibility and can reduce the concern of over-saving for college. As noted earlier, there’s still some time to plan for this change, starting in 2024, and we await further guidance from the IRS on certain details. Subscribe to stay up to date on legislation updates and financial planning insights.

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Please consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this article is not intended as legal or tax advice.

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