Contributed by: Josh Bitel, CFP®
Before the passing of SECURE ACT 2.0 in late 2022, folks with unused funds sitting in a 529 account had a few options for using leftover 529 funds. Generally speaking, the most common options were:
Save the funds for future educational use (either for the current or future beneficiary) or
Withdraw the money and pay federal income taxes and a 10% penalty on any gains within the account.
While these options may be feasible for some folks, others are left scratching their heads when they see leftover funds in a 529 plan when their child finishes college. This can also be a concern if a student wins a scholarship, attends a military academy, or receives unexpected gifts to help pay for school.
Fortunately, among the legislative changes brought forth by SECURE ACT 2.0 is a solution to help ease some of these concerns. Starting in 2024, 529 account holders are permitted to roll excess college savings plan funds into a beneficiary’s Roth IRA without incurring taxes or penalties. Sounds great, right? Well, as with most new laws, there is some important fine print to understand before going forward with such a transfer:
The 529 plan must have been open for at least 15 years before you can execute a rollover to a Roth IRA.
Rollovers are subject to the annual Roth IRA contribution limit. For 2024, this limit is $7,000. Additionally, if the beneficiary makes any IRA contributions in a given year, the eligible 529 to Roth IRA rollover amount is reduced by the size of that contribution. For instance, if the beneficiary contributes $3,000 to an IRA in 2024, the eligible rollover amount decreases to $4,000, based on the 2024 total IRA contribution limit set by the IRS.
529-to-Roth rollovers are subject to a lifetime limit of $35,000 per beneficiary. So, if you wanted to roll over the entire $35,000, you would have to do it over five years under the current 2024 contribution limits. (Although IRA contributions limits tend to rise in most years with inflation).
529 plan contributions made in the last five years cannot be transferred to a Roth IRA (including any earnings accrued on those contributions).
The beneficiary of the 529 plan must match the owner of the Roth IRA. For example, if you have a 529 for your grandson Teddy, you can only roll over any excess funds to a Roth IRA in Teddy’s name.
Just as when making a normal contribution to a Roth IRA, the owner must have earned income at least equal to the amount of the rollover. For example, if Teddy has a part-time job earning $4,000 in 2024, you may only roll over $4,000 in 529 funds to the Roth for that year.
There are no income limits restricting a 529-to-Roth rollover for either the beneficiary or 529 owner. For someone contributing directly to a Roth IRA (not using 529 funds) they are not permitted to do so if they earned $161,000 or more in taxable income as a single person in 2024. This rule does not apply to 529-to-Roth rollovers, so it is an excellent way for high earners to get money into a Roth.
As you can see, there is a lot to know before performing one of these rollovers, but for the right person, this can be a great retirement savings option. A more concise flowchart can be found here to help determine if you or your beneficiary is eligible for this transfer.
Overall, this new provision is a great way for savers to utilize excess 529 funds penalty and tax-free. However, there are still many questions that remain unanswered as it pertains to SECURE ACT 2.0. We are continuing to monitor and research as more details emerge. We will provide additional information as it is available, but if you have any questions about how this could affect you, please contact your Financial Planner. We are always happy to help!
Josh Bitel, CFP® is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® He conducts financial planning analysis for clients and has a special interest in retirement income analysis.
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc.
Center for Financial Planning, Inc. is not a registered broker/dealer and is independent of Raymond James Financial Services.
Keep in mind that, unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
Any opinions are those of Josh Bitel and Center for Financial Planning, Inc., and not necessarily those of Raymond James. This information is intended to be educational and is not tailored to the investment needs of any specific investor. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results. Diversification and asset allocation do not ensure a profit or protect against a loss This material is general in nature and provided for informational purposes only. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor's or the designated beneficiary's home state offers any tax or other benefits that are only available for investment in such state's 529 college savings plan. Such benefits include financial aid, scholarship funds and protection from creditors. The tax implications can vary significantly from state to state.