A 529 plan is a popular means of saving for a child’s college education, which is a significant financial goal for many parents. However, what happens if your child doesn’t want to attend college, or you save more than you need? When this occurs, you may want to consider rolling over the unused 529 funds to a Roth IRA.
What is a 529 rollover to a Roth IRA?
A 529 rollover to a Roth IRA is when you move funds from a 529 college savings plan to a Roth IRA retirement account. This means that you can use the money for your child’s retirement, rather than just college expenses.
When you do the rollover, you won’t be subject to taxes and the 10% penalty, under certain conditions. Once the funds are in the Roth IRA, they can continue to grow tax-free. Some people have called this 529 to Roth IRA rollover, the new Backdoor Roth.
Can I roll unused 529 funds into a Roth IRA?
On December 23, 2022, Congress passed a $1.7 trillion federal omnibus spending package. As a result, starting in 2024, you can do a tax-free rollover of your unused 529 funds into a Roth IRA if you meet the requirements.
What are the rules for converting a 529 to a Roth IRA?
- 529 to Roth IRA rollovers can only be made beginning on January 1, 2024.
- 529 plan beneficiaries can roll over up to $35,000 to a Roth IRA over their lifetime.
- The 529 account must be more than 15 years old.
- Rollovers are subject to Roth IRA annual contribution limits. The Roth IRA annual contribution limit for 2023 is $6,500 (or $7,500 for those aged 50 and older).
- The rollover is subject to the requirement that a Roth IRA owner must have earned income at least equal to the amount of the rollover.
- Account holders and beneficiaries cannot roll over any contributions, or earnings on contributions, that were made in the last five years.
How much can you rollover from a 529 to a Roth IRA?
Beginning on January 1, 2024, you will have the option to roll over up to $35,000 over the course of your lifetime from any 529 account in your name to a Roth IRA in your name. This is also dependent on the beneficiary’s earned income and any additional Roth IRA contributions made. For example, if the beneficiary has already contributed $2,000 to a Roth IRA, the maximum they could roll over for 2024 is $4,500.
Who can receive the funds from the 529 rollover to a Roth IRA?
Rollovers can only be made to the Roth IRA by the beneficiary of the 529 account.
How long do you have to own the 529 account?
The 529 account must have been opened in the beneficiary’s name for more than 15 years and the rollover amount must have been in the account for more than 5 years.
Does the beneficiary need to have a job to rollover a 529 to a Roth IRA?
Yes, the beneficiary must have earned income to complete a rollover from a 529 to a Roth IRA. The rollover is subject to the same rules as a Roth IRA. For example, if the beneficiary has only earned $3,000 that year, they can only complete a rollover for $3,000.
What are the steps to rollover a 529 plan to a Roth IRA?
Step 1: Determine eligibility
Not all 529 plans are eligible for a rollover to a Roth IRA. You need to check with your 529 plan provider to confirm if you can do a 529 rollover. In addition, you need to ensure that you are eligible to contribute to a Roth IRA. To do so, you must have earned income for that year and your modified adjusted gross income (MAGI) must be below a certain threshold.
Step 2: Open a Roth IRA
If you don’t already have a Roth IRA, you will need to open one with a qualified custodian. The Roth IRA contribution limit for 2023 is $6,500.
Step 3: Transfer funds with a direct rollover
You will need to do a direct rollover to transfer the funds from your 529 plan to your Roth IRA. This means that you will ask your 529 plan provider to send the funds directly to your Roth IRA custodian. Make sure that you don’t receive the funds yourself as this could trigger taxes and penalties. As long as the funds go directly to your Roth IRA, the transaction will be tax-free and you also won’t be subject to the 10% early withdrawal penalty.
Step 4: Invest the funds
Once the funds are in your Roth IRA, you can invest them in a variety of assets. These include stocks, bonds, mutual funds, or exchange-traded funds (ETFs). Make sure that you talk to your financial advisor to ensure that your portfolio is diversified and aligns with your risk tolerance and financial goals.
When can you roll over a 529 plan to a Roth IRA?
The new rules come into effect on January 1, 2024. This means that everything will be as-is for 2023 and then in 2024, you will be able to do a tax-free 529 rollover to a Roth IRA.
Can I start planning for my 529 plan rollover to a Roth IRA now?
If you are already thinking about rolling your 529 plan over to a Roth IRA, then it might be a good idea to consult your financial advisor. They will be able to help you decide if it’s the best decision for you and your family. While the new rules do add some flexibility to 529 plans, 529 plans are already more flexible than many people realize.
What else can I do with unused 529 funds?
There are several options available to you if you have unused funds and you don’t want to do a rollover.
- Change the beneficiary: If you have another child or family member who may benefit from the funds for education expenses, you can designate that person as the new beneficiary.
- Save the funds for future education expenses: You never know when you may want to go back and further your education. You can always leave the 529 funds in your account. There is no time limit on using the funds and they can continue to grow tax-free.
- Withdraw the funds and pay taxes: You can always withdraw the unused funds but you will be subject to federal and state taxes on any earnings, as well as a 10% penalty on those earnings.
Should I invest in a Roth IRA or a 529 plan for my child’s financial future?
They are both tax-smart ways to set aside money for your child’s future. We discuss the advantages and disadvantages of each in our 529 plan vs Roth IRA blog.
Do you need help rolling over your unused 529 funds to your Roth IRA in 2024?
This is a major change for 529 plans. It’s a huge step in the right direction to help families feel more secure about using a 529 to invest in their child’s future. Rolling over your unused 529 funds to your Roth IRA can be a smart financial decision if you have excess funds or if your child decides not to go to college. However, it’s important to understand the rules before completing the rollover. If you want help with your finances and are interested in having a comprehensive financial plan, feel free to schedule a discovery call with one of our financial advisors today!
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.
