Can You Rollover a 529 Into an IRA?
Parents often save for their child’s college education by contributing to a 529 plan. These accounts offer various investment portfolios geared specifically toward saving for higher education costs based on age.
Beginning in 2024, beneficiaries can withdraw up to $35,000 tax-free into a Roth IRA without incurring income or penalty taxes on withdrawal.
Contributions
Starting in 2024, families may be eligible to transfer any leftover 529 plan funds into a Roth IRA account. Under new rules set to go into effect, families may be able to roll over this extra savings account into Roth IRAs as long as the person moving the money has been designated beneficiary for at least five years and does not exceed the annual limit ($6,500 during 2023).
A 529 account is an investment vehicle used by parents to save for college expenses of their children or grandchildren. Funds in such accounts may be distributed among different portfolios – static fund portfolios as well as age-based ones which automatically shift toward more conservative investments as the beneficiary approaches college age.
Families may struggle to strike a balance between saving for education and retirement savings accounts such as 529 plans, which often leave money sitting idly idly in 529 accounts but never used for qualifying education expenses. Switching over to Roth IRAs eliminates this trade-off between these accounts.
Taxes
A 529 plan provides significant tax advantages, such as state income tax deductions in 35 states and D.C. and investment earnings that grow tax-deferred federally. Furthermore, accounts qualify for up to $14,000 of gift tax exemption per beneficiary each year regardless of number of contributors or total contribution amounts.
Investors have the choice between age-based or customized investment strategies managed by Fidelity or other providers as well as self-directed options. Contributions may also be made in honor of friends and family; however, changing beneficiary could alter your tax treatment.
Withdrawals from 529 plans may be used for any number of educational expenses and assets can easily be transferred between beneficiaries at any time. If withdrawals aren’t used to cover qualified education expenses, income taxes and a 10% penalty could apply; this can apply to funds taken out after death, disability, or receiving an eligible scholarship award.
Withdrawals
The new rollover rule will enable families with 529 accounts to use any unused funds for qualified expenses, but withdrawing them for non-qualified expenditures (such as personal reasons) will result in income taxes and a 10% penalty fee.
Assume Jake withdraws $5,000 from his child’s 529 account for emergency expenses. Only $2,000 counts as earnings and will therefore incur both penalties of $100 plus federal income taxes totalling $240.
The new rules provide greater flexibility for families when changing beneficiaries. While you could previously only switch a 529 account’s beneficiary to another sibling or child of its original beneficiary, now any family member including: spouse; child (stepchild or adopted), brother-sister couple or their spouse(s), parent/guardian; first cousin & their spouse and even you yourself can become beneficiaries – keep this account and use it to name someone as the recipient; even keep this account and designate it as the beneficiary for a child or grandchild of yours or grandchild’s 529 account as long as it remains beneficiary!
Conversions
Parents and grandparents use 529 plans as an effective way to save for college expenses for their children or grandchildren, yet many funds remain unutilized. Under current rules, withdrawals from 529 accounts are subject to income tax as well as an additional 10% federal penalty tax for nonqualified education expenses.
Example: Carol’s parents contributed more than $35,000 to her 529 account and it remains unspent, leading to taxes being assessed against the remainder. For this reason, many grandparents opt to convert any unutilised funds in their 529s into Roth IRAs in order to reduce any potential tax obligations on remaining balances.
SECURE Act 2.0 offers 529 plan account owners the option of rolling over up to $35,000 of excess assets into beneficiary’s Roth IRA beginning in 2024, as long as their IRA has been open for at least 15 years and annual conversions do not exceed annual and lifetime contribution limits (typically $6500 and $35,000, respectively). This rule gives people more choices for saving for retirement.
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