Can a 529 Plan Be Rolled Over Into a Roth IRA?
If your child’s plans have changed or you have 529 plan funds that have gone unused, new rules passed in the Omnibus Spending Bill will soon allow tax-free rollovers into Roth IRAs, beginning 2024. Before making any decisions about tax or finance matters. Please consult a CPA or financial planner.
Savings made in a 529 plan are eligible for tax-free withdrawal when used for qualifying education expenses, but transferring between accounts or changing beneficiaries could incur taxes and penalties.
If you withdraw funds from a 529 to pay for non-qualifying expenses such as purchasing a computer or paying off credit card debt, any earnings on distribution are subject to income taxes and an additional 10% penalty as they were originally invested with after-tax dollars.
Change the beneficiary to someone in your family or transfer funds to a Roth IRA (under certain conditions), and any earnings portion of withdrawal will be exempt from taxes. Plus, 529 funds can be rolled over once per year without penalty – although you should keep this tax consideration in mind when planning your strategy. You could even transfer them into another state’s plan; though their investment options will likely differ accordingly.
A 529 education savings account allows parents, relatives and friends to save for future college expenses in an investment account that allows them to be taxed as regular income. When withdrawing funds they may incur an additional 10% penalty if not used towards qualifying educational expenses.
Last year’s $1.7 trillion federal omnibus spending bill contains a provision enabling 529 plan earnings to rollover into Roth individual retirement accounts starting in 2024 if their plan has been open for at least 15 years.
Before undertaking a rollover, it is crucial to first establish whether the new state offers tax deductions on contributions. You also should ensure that any new plan doesn’t have contribution or withdrawal limits that exceed the total of your rollover. A CPA or fiduciary financial advisor may help guide your efforts while only one tax-free rollover per beneficiary per 12-month period can take place tax free.
As with any investment, withdrawing from a 529 plan at the right time can significantly impact its value. Early withdrawal can result in forgoing potential investment gains while delaying could mean incurring higher educational costs later.
Target-date funds offer one effective solution to prevent losses; they automatically adjust over time as beneficiaries near college age, becoming more conservative as time goes on. Even so, this strategy does come with inherent risks as it’s impossible to accurately anticipate market bottoms.
States often offer their own plans, and an astute investor may find one with better performance or lower fees – for instance West Virginia offers low fees with Vanguard and Invesco funds available there. When considering rolling over to another state’s plan, keep this tax consideration in mind as any inbound or outbound states could treat this investment change as an investment change that impacts tax status.
If an original beneficiary no longer needs or desires the 529 funds, they can be transferred without incurring federal income taxes or penalties. Each state may impose restrictions that limit how often this can occur within any 12-month period and ensures the new beneficiary meets qualification as an immediate relative of the old beneficiary.
Rollover can be beneficial if the original beneficiary no longer wishes to use their funds, or is moving into an area offering tax deductions on contributions. However, multiple rollovers in one year would constitute nonqualified distribution and earnings may be subject to federal income tax as well as a 10% penalty tax.
If the beneficiary decides not to attend college or believes they cannot afford it, they can change the beneficiary to someone within their immediate family such as siblings, parents, or spouse. Or use it toward education expenses like trade schools or registered apprenticeship programs.
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