529 plan savers can now transfer unused funds while keeping the tax benefits. The recently signed $1.7 trillion government spending package has a provision that allows Americans to roll money from a 529 plan to a Roth IRA, free of both income taxes and penalties. The rollover measure will take effect in 2024. The rollover can occur if a beneficiary (such as a child or grandchild) does not attend a college, university, vocational or private K-12 school, or other qualifying institution, or if the student receives a scholarship; and in turn has 529 funds that are left over. There are limitations, which are listed below.
529 plans carry tax advantages for college savers. The main advantage is that investment earnings on account contributions grow tax-free and are not taxable when distributed; so long as the funds are used for qualifying education expenses like tuition, fees, books, and room and board. If the funds are not used for qualifying education expenses, the investment growth is subject to income tax and a 10% tax penalty.
This is where rollovers to a Roth IRA would be beneficial. A transfer to a Roth IRA would remove such income taxes and penalties, then allow investments to continue growing tax-free in a Roth account.
Limitations on 529-to-IRA transfers
The new 529-to-Roth IRA transfer provision doesn’t carry income limits. However, there are several other limitations on the rollovers. These include:
-A $35,000 lifetime cap on transfers.
-Rollovers are subject to the annual Roth IRA contribution limit. (The limit is $6,500 in 2023.)
-The rollover can only be made to the beneficiary of the 529 plan — not that of the account owner. In other words, a 529 owned by a parent with the child as beneficiary can only be rolled into the child’s IRA, not the parent’s.
-The 529 account must have been open for at least 15 years; changing the account beneficiary will restart the 15-year clock.
-Account owner can’t roll over contributions (or earnings on those contributions) made in the last five years.
Currently in the U.S., there are millions of 529 accounts that hold billions in savings. According to the Investment Company Institute, there were nearly 15 million 529 accounts at the beginning of 2022, holding a total of close to $500 billion. That averages out to over $30,000 per account.
If you’ve set up a 529 plan for a beneficiary that may not need the funds for school and could potentially benefit from the new Roth provision, give us a call. We’re happy to help analyze if this strategy could provide a retirement benefit from the funds you had set aside for college.
