New Rules Make It Easier to Roll Over 529 Plans

Changes to beneficiary of 529 plans could potentially compromise eligibility for financial aid; however, new rules that come into force in 2022 make switching over easier.

Federal tax laws permit one tax-free rollover per beneficiary every 12 months; any further transfers could result in income taxes and a 10% penalty being assessed against your transfer.

Tax-free rollovers

As children are known to change their minds quickly, parents may feel pressured into locking in college savings with certainty. Thanks to new rules, however, unused college funds can now be transferred directly to a Roth IRA without penalty; provided the beneficiary of the account are family members, such as spouse, child or sibling of current beneficiary; otherwise they could incur federal taxes as well as an earnings-related 10% penalty on earnings from an account owner’s earnings.

Are You Thinking About Transferring Your 529 Plan Funds? Several reasons could lead you to do this, such as seeking better investment options, state tax deductions, or moving. But please keep in mind that you cannot make more than one rollover every 12 months; also note that any rollover to an ABLE account could reduce financial aid eligibility by 50% as cash support payments used to cover education are considered cash support payments that could reduce need-based assistance eligibility.

Recapture tax rules

A 529 rollover refers to the process of moving money from one 529 college savings plan into another – or switching beneficiaries of an existing plan – without incurring tax liabilities, yet can have long-term performance implications that affect long-term performance. When rolling over funds it’s essential that all aspects are carefully considered – tax implications aside, market timing matters too!

State income tax deductions could also be affected when moving state. The IRS allows one tax-free rollover per beneficiary annually; to ensure no clawback from previously taken deductions occurs.

Another key point about 529 plans is their one-per-year beneficiary change limit, which can present challenges when there are major life changes or transitions within a family unit. Furthermore, changes could incur tax penalties.

State tax deductions

As it’s possible to change the beneficiary of a 529 plan at any time, be mindful that doing so may have tax repercussions. According to IRS regulations, account owners are eligible for one tax-free rollover per beneficiary in any 12-month period.

Decisions on 529 rollovers depend on multiple factors, including where you live and if the new plan fits with your needs. For instance, if your new state offers tax deductions for contributions made to its 529 plans, doing a rollover could be worthwhile.

But remember the recapture tax rules, which could penalize you if you switch plans. Some states will even clawback deductions claimed on 529 contributions made from out-of-state accounts if these funds are moved into their plans from outside accounts, leading to unexpected tax bills that may require professional advice in order to avoid unpleasant surprises. It would be wise to consult a CPA when planning for such eventualities.

Beneficiary changes

If you own a 529 plan and would like to alter its beneficiary, be mindful that only one tax-free rollover per beneficiary per year can take place tax free – any more will incur penalties from both account owner and beneficiary. This rule applies equally.

A change to an original beneficiary requires finding an eligible relative of that original beneficiary – such as siblings, parents, spouses, aunts/uncles/cousins – who will accept responsibility at age 18 when making this change.

Transferring a 529 account takes time and during that period you could miss out on investment returns from the market – something which could negatively impact your portfolio over time.

Last year’s $1.7 trillion federal omnibus spending package included a provision enabling individuals and families to roll over up to $35,000 from 529 plans into Roth IRAs starting in 2024, giving families with college savings extra opportunity to use those savings for retirement purposes.


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