Can I Roll a 529 Plan Into a Roth IRA?
If a 529 account is used for nonqualifiable expenses, its owner could incur both federal income taxes and a 10% federal penalty tax. Under new rules created by the SECURE 2.0 Act, individuals can roll unused 529 funds into a Roth IRA if certain conditions are fulfilled.
Accounts with leftover funds could benefit from changing their beneficiary to someone who could put the funds toward education expenses or pay their graduate school tuition costs.
What Is a 529 Plan?
A 529 plan is an education savings account with tax advantages for families. Individuals can invest funds in professional-managed mutual or exchange-traded funds that offer tax breaks. Withdrawn funds may then be used towards qualified higher education expenses at eligible schools without incurring tax penalties or tax returns.
Most states offer state-sponsored plans, but families don’t need to limit themselves to just their state’s options. NerdWallet provides a useful list of available plans with descriptions and investment options for each. Many states also provide tax deductions.
Under old rules, withdrawal earnings from a 529 account for nonqualified purposes would incur ordinary income tax and a 10% federal penalty. Beginning in 2024, however, thanks to new provisions in the SECURE Act allowing beneficiaries to roll over up to $35,000 of lifetime contributions into Roth IRAs which is an effective strategy for long-term estate and gift planning according to one financial planner in Wilmington N.C.
How Does a 529 Plan Work?
Parents and grandparents looking to save for the education of their children or other family members can use 529 college savings plans as an effective tool. Withdrawals from 529 plans can be tax-free as long as the funds are used towards qualified expenses such as tuition fees, books supplies and room and board at qualified colleges and universities in the US.
State-sponsored 529 plans provide families with various investment portfolio options, such as static fund and age-based portfolios, in addition to estate planning and investment flexibility benefits. Accounts may also be easily changed over to another qualifying family member at any time – such as their spouse, child or other descendant; sibling, step-sibling; parent or in-law; first cousin with their spouse or niece/nephew if applicable.
Example: Say Carol’s parents save $250 every month until she turns 18. When invested in mutual funds with an average annual return rate of 10%, that account would grow to over double its original size in 13 years – one reason 529 plans are so popular.
How Can I Convert a 529 Plan to a Roth IRA?
One provision in the recently passed $1.7 trillion government funding package allows savers to repurpose unused college savings by rolling them over into a Roth IRA, free from taxes and penalty fees. It’s an intriguing option for people using 529 plans for educational expenses while looking for tax-free retirement savings for themselves.
Roth IRAs provide more freedom when investing money, making them attractive options for those who seek greater risk-taking with their investments and higher returns.
However, there are restrictions in place. To qualify, you must make a trustee-to-trustee transfer between 529 plans and Roth IRAs by June 30th 2024; any amounts transferred cannot exceed $35,000. There’s also a lifetime rollover limit of $35,000 per person; that amount represents how much can be moved annually between accounts without waiting until next calendar year to transfer more.
How Can I Transfer Unused 529 Account Funds?
Uses for unallocated 529 funds vary: leaving them in your account, changing beneficiary to another family member who qualifies, or even moving them into a Roth IRA if they meet certain requirements. Withdrawals made for nonqualified expenses will incur federal income tax at your ordinary rate as well as an additional 10% penalty fee.
If you choose to withdraw the funds, they can be put towards any form of higher education expenses, from community college to trade school and even student loan repayment for either your beneficiary or their siblings.
However, in order to do this successfully you’ll need to meet several criteria. Your original account must have been open for at least 15 years and no more than $35,000 can be moved per beneficiary into a Roth IRA – plus the annual Roth IRA contribution limit remains in force if applicable. For any questions on this topic speak with an advisor.