Funds in a 529 college savings plan can be transferred, or rolled over, into a Roth IRA (a 529-to-Roth IRA transfer) starting next year.
- Key Points about 529-to-Roth IRA Transfers
- The 529-to-Roth IRA Transfer Rule
- Limitations on 529 to Roth IRA Conversions
- Understanding 529 College Savings Plans
- How Does the 529-to-Roth IRA Work? An Illustration
- Planning Ahead and Maximizing the Transfer Rule
Key Points about 529-to-Roth IRA Transfers
- The SECURE 2.0 Act introduced a 529-to-Roth IRA transfer rule, allowing tax-free transfers of unused college savings.
- The new rule provides flexibility and removes barriers to overfunding 529 plans.
- Limitations include a lifetime maximum transfer, a 15-year account requirement, restrictions on recent contributions and earnings, and adherence to annual Roth IRA contribution limits.
- Planning ahead and optimizing the transfer process are crucial for maximizing benefits.
- The transfer rule offers an opportunity to repurpose unused college savings for retirement planning and long-term financial security.
The recently passed SECURE 2.0 Act of 2022 introduced a new rule. This rule, under Section 126 of the Act, allows distributions from 529 plans to Roth IRAs, enabling the transfer of unused college savings to a beneficiary’s retirement savings without incurring taxes or penalties. The rule is set to come into effect in 2024.
The 529-to-Roth IRA Transfer Rule
The new rule, established by the SECURE 2.0 Act, introduces the ability to transfer funds from a 529 plan to a Roth IRA. This means that any remaining balance in a 529 plan after the beneficiary completes their education can be moved to a Roth IRA, providing greater flexibility for families in managing their savings. The key benefit of this rule is the opportunity for tax-free transfers, allowing families to maximize the potential for tax-free growth on their college savings.
The new 529-to-Roth IRA transfer rule addresses the limitations that previously deterred families from overfunding 529 plans. Previously, if a beneficiary completed their education without fully utilizing the funds, there were limited options available for the remaining balance, such as changing the beneficiary, paying off education loans, or incurring taxes and penalties through nonqualified withdrawals. However, with the new rule, families no longer have to worry about unintended taxation and can optimize the tax-free growth potential of their college savings.
Limitations of the Transfer Rule:
To ensure that 529 plans are primarily used for educational funding and not solely as wealth transfer vehicles, the transfer rule imposes certain limitations.
These include a lifetime maximum transfer of $35,000 per beneficiary, a requirement for the 529 account to be in existence for at least 15 years, restrictions on transfers of contributions made within the last five years, and adherence to annual Roth IRA contribution limits. These limitations aim to strike a balance between flexibility and responsible use of the transfer rule.
The restrictions include:
- $35,000 lifetime maximum on transfers from a 529 to a Roth IRA per beneficiary.
- Transfer is subject to the annual Roth IRA contribution limit. (The limit is $6,500 in 2023.) This including all funds contributed during the year, both 529 transfers and any other contributions.
- The Roth IRA account receiving 529 transfer funds must be in the name of the beneficiary of the 529 plan. Meaning, a qualified tuition plan owned by a parent (e.g., a 529 plan) with the child as beneficiary would need to be rolled into the child’s Roth IRA, not the 529 owners (i.e., not the parent or grandparent).
- The 529 account must be open for the beneficiary for 15 years. (Not clear at this time how changing the beneficiary impacts this limitation).
- Contributions made to 529 plan within past 5 years (and the earnings on those contributions) are not eligible to be transferred to a Roth IRA.
Understanding 529 Plans:
Before delving into the specifics of the transfer rule, it’s important to have a clear understanding of 529 plans.
529 college savings plans are tax-advantaged investment accounts specifically designed to help families save for higher education expenses. The primary purpose of 529 plans is to save and invest money for qualified higher education expenses, including tuition, fees, books, supplies, and certain room and board costs.
Tax Advantages:
One of the main advantages of 529 plans is their tax benefits. While contributions to a 529 plan are not deductible on your federal income tax return, the earnings in the account grow tax-free. Additionally, withdrawals from the plan for qualified education expenses are also tax-free at the federal level. Many states also offer tax incentives such as deductions or credits for contributions to a 529 plan.
State-Sponsored:
529 plans are sponsored by states, and each state has its own plan(s). However, residents of any state can usually invest in any state’s 529 plan.
Impact on Financial Aid:
While 529 plan assets are considered an asset of the account owner, they generally have a relatively low impact on financial aid eligibility compared to parental income.
Account Ownership and Beneficiaries:
A 529 plan typically has an account owner (often a parent or guardian) who controls the account and designates a beneficiary (typically a child or grandchild) who will use the funds for educational expenses.
Beneficiary Designation:
If the original beneficiary of a 529 plan does not use all the funds or decides not to attend college, the account owner can change the beneficiary to another eligible family member without incurring taxes or penalties.
Non-Qualified Expenses:
If funds are withdrawn from a 529 plan for non-qualified expenses, you may be subject to income tax and a 10% federal tax penalty on the distribution.
529 college savings plans provide families with a tax-advantaged way to save and invest for higher education expenses. They offer flexibility, investment options, and potential state tax benefits, making them a popular choice for individuals seeking to financially prepare for future educational costs.
See The Ultimate Guide: Converting US Savings Bonds to a 529 Plan for details on funding a 529 plan with proceeds from U.S. Savings Bonds.
How Does the 529-to-Roth IRA Work? An Illustration:
To better grasp how the transfer rule operates, let’s consider a few hypothetical scenarios involving a beneficiary named Felix.
Scenario 1: A mature 529 plan with under $35,000 remaining
His parents opened a 529 plan for him at age 5 and made regular contributions until his 18th birthday. Felix graduates’ college at 22 and immediately starts earning an income. Contributions to an IRA are only allowed up to the amount of earned income in that year.
At graduation, Felix has $26,000 remaining in the 529 plan. So, starting after graduation, Felix can initiate a direct trustee-to-trustee transfer from his 529 plan to his Roth IRA. He can perform rollovers each year up to the maximum contribution limit until he has depleted the 529 account.
| Age | Beginning 529 Balance | Transfer to Roth IRA | Remaining Balance |
| 22 | $26,000 | $6,500 | $19,500 |
| 23 | $19,500 | $6,500 | $13,000 |
| 24 | $13,000 | $6,500 | $6,500 |
| 25 | $6,500 | $6,500 | $0 |
(For simplicity of the illustration, we have assumed no future earning within the 529 plan and no change to the annual Roth IRA contribution limit)
Scenario 2: A recent 529 plan and under $35,000 remaining
His grandparents opened a 529 plan for him at age 12 and made regular contributions until his junior year of college (age 21). Felix graduates’ college at 22 and immediately starts earning an income.
At graduation, Felix has $10,000 remaining in the 529 plan. Before making a 529-to-Roth IRA transfer, Felix must wait until the account has been open 15 years. In this scenario, that would be when he turns 27 years old.
Once the account is 15 years old, he can perform rollovers each year up to the maximum contribution limit until depletes the 529 account.
| Age | Beginning 529 Balance | Transfer to Roth IRA | Remaining Balance |
| 22 | $10,000 | $0 | $10,000 |
| 23 | $10,000 | $0 | $10,000 |
| 24 | $10,000 | $0 | $10,000 |
| 25 | $10,000 | $0 | $10,000 |
| 26 | $10,000 | $0 | $10,000 |
| 27 | $10,000 | $6,500 | $3,500 |
| 28 | $3,500 | $3,500 | $0 |
(For simplicity of the illustration, we have assumed no future earning within the 529 plan and no change to the annual Roth IRA contribution limit)
Scenario 3: A mature 529 plan, but with recent contributions
His parents opened a 529 plan for him at birth and made regular contributions throughout his college years. Each year during college, $2,000 per year in contributions were made.
Felix graduates’ college at 22 and immediately starts earning an income. At graduation, Felix has $20,000 remaining in the 529 plan. Felix can initiate a transfer from his 529 plan to his Roth IRA. He can perform rollovers each year up to the maximum contribution limit.
But he must make sure that any contributions (and their associated earnings) have been in the plan for at least 5 years. Hence, after he transfers the “aged” funds, he can only transfer $2,000 per year as the newer contributions reach their 5-years in the plan minimum.
| Age | Beginning 529 Balance | Contributions + Earnings | Transfer to Roth IRA | Remaining 529 Balance |
| 18 | $12,000 | $2,000 | N/A | $14,000 |
| 19 | $14,000 | $2,000 | N/A | $16,000 |
| 20 | $16,000 | $2,000 | N/A | $18,000 |
| 21 | $18,000 | $2,000 | N/A | $20,000 |
| 22 | $20,000 | $0 | $6,500 | $13,500 |
| 23 | $13,500 | $0 | $6,500 | $6,000 |
| 24 | $6,000 | $0 | $2,000 | $4,000 |
| 25 | $4,000 | $0 | $2,000 | $2,000 |
| 26 | $2,000 | $0 | $2,000 | $0 |
(For simplicity of the illustration, we have assumed no future earning within the 529 plan and no change to the annual Roth IRA contribution limit)
Planning Ahead and Maximizing the Transfer Rule:
To make the most of the 529-to-Roth IRA transfer rule, strategic planning is essential. Families should open a 529 College Savings Account early and contribute regularly to allow ample time for the account to mature. The account should be open, and with the same beneficiary, for at least 15 years before considering a Roth IRA transfer.
So, assuming the goal is an initial 529-to-Roth IRA transfer immediately after graduating from college, the 529 plan should be opened before your child’s 7th birthday. That is, 15 years before they would potentially graduate college at age 22.
By doing so, you can optimize the benefits of the transfer rule when the time comes. Additionally, considering factors like previous IRA contributions and income limitations can help individuals tailor their approach and maximize the potential of the transfer process.
Conclusion:
The 529-to-Roth IRA transfer rule introduced by the SECURE 2.0 Act offers an excellent opportunity for families to repurpose unused college savings and jump-start their retirement savings. By addressing the concerns surrounding overfunding 529 plans, the rule provides greater flexibility and tax advantages. However, it’s crucial to understand the rules and limitations and consult with tax, investment, and legal advisors to make informed decisions based on individual circumstances. Staying updated with official guidance from the U.S. Treasury is also advisable.
Given the complexity of tax and investment matters, it’s important for individuals to seek guidance from professionals such as tax advisors, investment advisors, and legal advisors. They can provide personalized advice based on specific circumstances and ensure compliance with regulations. Additionally, it is crucial to stay informed about any official and final guidance provided by the U.S. Treasury regarding the 529-to-Roth IRA transfer rule.
(Note that final regulation regarding this rule have not been published. This article is our understanding of the requirements today and is based on this summary of the legislation.)
