Can I Roll a 529 Plan Into a Roth IRA?
Under a new law, 529 account funds (up to $35,000 of lifetime limits) may be rolled into Roth IRA accounts without incurring penalties or income taxes – provided you do so responsibly.
Before transferring 529 plan funds into a Roth IRA, carefully consider your other financial goals – which may include paying off consumer debt, creating an emergency fund and investing 15% of your income into retirement accounts.
Taxes
A 529 account offers tax-free growth when used for qualified education expenses such as tuition fees, books and room and board costs. Investment earnings, however, will be subject to income taxes as well as an additional 10% penalty fee if withdrawn for other than educational use.
Under a recent law, beneficiaries can switch their 529 funds over to Roth IRAs without incurring taxes or penalties, but there are important details they should take note of before doing so.
To qualify for a rollover, for instance, the beneficiary must own their 529 plan for at least 15 years before making an IRA transfer directly from trustee-to-trustee transfer and not include contributions or earnings made over the last five years; additionally, annual limits apply.
Saving for college costs may be top of mind for most families, yet it is also essential to focus on other financial goals, like eliminating consumer debt and creating an emergency fund capable of covering 3-6 months’ living expenses.
Withdrawals
Savings held within a 529 plan don’t need to be used solely for educational expenses; if their beneficiary uses them for nonqualifying expenses instead, income tax and an earnings penalty of 10% could apply.
Starting in 2024, beneficiaries can use Secure Act 2.0 rules to transfer any unused funds in their 529 accounts into Roth IRAs of their own starting from 2024. However, to do this successfully the account must have been open for 15 years with contributions made within five years not eligible for rollover.
As it remains unclear whether this 15-year clock resets with any change to beneficiary, and industry is waiting for further guidance from the IRS regarding how these situations should be managed, having funds transferred directly into Roth IRAs could provide people a way of protecting their savings from taxes once their kids finish college; but also act as an important reminder about the costs associated with higher education – and therefore reminding them of the need to continue saving.
Rollovers
Under new rules, families who possess 529 funds they no longer want can convert them to Roth individual retirement accounts (IRAs) without incurring tax penalties, making this new provision of Congress’ SECURE Act 2.0 even more flexible for investment options for education savings.
But the rules surrounding rolling 529 funds into a Roth IRA can be complex and must be carefully considered before any decision is made. A financial professional familiar with both strategies could help guide your decision.
According to law, you may only roll your 529 account over once in any 12-month period and the transfer must be direct (plan-to-plan or trustee-to-trustee), not by check. Otherwise, this transaction would be treated as an nonqualified distribution and you may face taxes and a 10% penalty on earnings accumulated over time.
Additionally, there are restrictions on how much money can be rolled over each year that depend on annual Roth IRA contribution limits and beneficiary’s earned income.
Investments
A 529 plan invests in a range of stock and bond mutual funds managed either by state government agencies, or privately through firms like Vanguard, Schwab or Fidelity. Some plans are administered by states while others can be found with private firms like Vanguard, Schwab and Fidelity; age-based portfolios may also be made available which gradually scale back riskier holdings as the college graduation date approaches. Beginning 2024 under SECURE Act 2.0 provisions allow unused assets from 529 plans to be rolled over into Roth IRAs established under their beneficiary’s name.
Rollover accounts can serve as a safe haven for those unable to meet their college savings goals or who wish to shift the focus of their investment strategy toward retirement. Before considering such options, several crucial considerations must be addressed beforehand, including:
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