Can a 529 Plan Be Rolled Over?
If you are considering rolling over funds from a 529 account into another plan, make sure you understand all of the rules involved. Federal law allows one tax-free rollover every 12 months.
At any point in time, you can change the beneficiary without incurring additional taxes or penalties as long as he or she is part of your immediate family – such as spouses, siblings, children, grandchildren, parents or first cousins. This makes sense for many reasons.
It’s Tax-Free
Typically, only one tax-free rollover may be completed in any 12-month period; however, you may transfer funds between an ESA and 529 plan or mutual fund and prepaid tuition plan without incurring taxes. Furthermore, redeem Series EE and I bonds and move their proceeds directly into an ESA without paying federal income taxes on them.
If you have unclaimed 529 plan funds, consider rolling them over into a Roth IRA. Secure Act 2.0 allows the transfer from 529 plans to Roth IRAs when beneficiaries change provided that the new beneficiary meets certain requirements such as having enough earned income to trigger the five-year holding period.
This change was implemented to address concerns that some parents were misusing their 529 contributions because their children failed to go to college or otherwise use the funds provided for higher education purposes, thus creating wasteful practices with regards to higher education expenses. With higher education becoming ever more costly, this issue must be taken seriously.
It’s Easy
A 529 plan rollover is an easy and quick way to change the beneficiary of an already funded account. This could come in handy if your family moves to a state with more favorable tax deductions on contributions or the account owner desires adjusting portfolio mix as the beneficiary approaches college age.
Account owners must remember that federal regulations only permit one tax-free rollover every 12-months per beneficiary and require opening their new account in one of the states participating in the program.
This step is essential, as each state offers different investment and tax deduction options for their retirement plans. If a new account holder doesn’t participate in their state plan, any earnings from non-qualified withdrawals could incur tax penalties that exceed federal guidelines; alternatively they could transfer their money into a Roth IRA which gives beneficiaries more control with how their dollars are utilized.
It’s Convenient
A 529 rollover is one of the easiest and most effective ways to transfer funds between plans. There are various strategies for doing this that each come with their own set of benefits and rules.
If your funds are spread among several 529 plans in different states, consolidating them to one with lower fees may make sense. Or if your current state doesn’t offer tax deductions on contributions it could be wiser to switch states that do offer such incentives.
Alternately, you can transfer funds without incurring a penalty by changing the beneficiary of the account to someone in your family. Eligible relatives include spouses; sons and daughters; brothers and sisters; parents, step-siblings and any age children of either step; as well as first cousins or their descendants. There’s no minimum amount required when changing beneficiaries – nor must you wait until graduate school has started before doing it – though withdrawals from 529 plans not used for qualifying education expenses will incur taxes plus an earnings penalty tax of 10% tax.
It’s Timely
Under new rules, beneficiaries are now permitted to roll over any unused 529 funds into Roth IRA accounts, which could be particularly useful for families that have saved too much for college and now must begin saving for retirement.
Scenario 2: Margo’s parents funded her 529 account with the intention of helping her pay for an Ivy League education, but instead decided she wanted to pursue art as her path into adulthood instead of traditional colleges or vocational programs. They are disappointed that they can no longer use these funds towards funding her tuition costs.
They decided to switch beneficiaries and transfer the funds from her 529 into her dad’s Roth IRA, which qualifies for tax deduction. But they must be mindful not to exceed one tax-free rollover every twelve months and avoid making the mistake of moving from plans which had received state tax deductions, as that could trigger recapture rules.
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