Contributing to a 529 account is a great way to help your kids save for college. But what if you put more money into the account than they wind up using for their education? In 2024, the SECURE 2.0 Act went into effect, which makes it possible to roll excess 529 funds into a Roth IRA for retirement purposes. That means you can use excess 529 funds to establish a retirement account for the 529 beneficiary.
How does a 529 rollover work? Let’s look at the finer details so you can decide if a 529 to Roth IRA rollover is right for you and your family. If you have questions, please reach out to our investing team. We can help you create the ideal investing plan for retirement planning, education savings, and more.
Understanding 529 Plans and Roth IRAs
529 plans are designed to offer tax advantages for those who want to save for future education expenses. The money you put into a 529 can grow tax-free. As long as you withdraw it for qualified education expenses, the withdrawals are tax-free at the federal level and many times at the state level as well.
Roth IRAs are designed for individual retirement needs. You do pay taxes on the money initially, such as income tax on your income, but when you pull the money out after age 59 and a half, you don’t have to pay taxes on the withdrawal. These plans allow you to grow retirement savings tax-free and penalty-free as long as you withdraw after the age restriction and as long as the account has been open for at least five years.
Each plan has a specific purpose – education vs retirement. The 529 plan rollover option is exciting because it allows you to use leftover education funds to build retirement savings instead of having to withdraw those funds with penalties if you don’t have any further education expenses.
The Benefits of Rolling Over from 529 to Roth IRA
Multiple benefits come with a 529 to Roth IRA rollover, including:
- Grow retirement tax-free: Moving money from a 529 to a Roth IRA allows those funds to grow without incurring taxes.
- Avoid penalty fees: Withdrawing funds from a 529 for anything other than education expenses incurs penalties, but if you roll the funds over to an IRA you avoid those penalties.
- Significant growth potential: The average beneficiary of a 529 plan can benefit from many years of retirement fund growth once the 529 to Roth IRA rollover is complete.
What are the tax implications of transferring money from a 529 plan to a Roth IRA? As long as you adhere to the rules of the program, you shouldn’t incur taxes on the rollover. Keep in mind that if you do perform a rollover, you will need to report the rollover on your tax return.
Considerations and Eligibility
What are the eligibility requirements for a 529 to Roth IRA rollover? Requirements include:
- The 529 account must be open for at least 15 years
- The beneficiary of the account needs to be consistent throughout those 15 years
- The beneficiary of the Roth IRA must have earned income within the tax year of the rollover
Some other considerations to keep in mind before choosing a 529 plan rollover include:
- A rollover is limited to $35,000 per beneficiary
- The rollover is limited to the annual Roth IRA contribution limit, which is currently set at $6,500 for those under 50 and $7,500 for those 50 years or older
- Only contributions made to the 529 five years before the rollover or before are available to rollover
Drawbacks and Limitations
A Roth IRA rollover has many advantages for the right individuals, but it is not a one-size-fits-all solution. Depending on your circumstances, the drawbacks and limitations of this type of investment transfer may mean you should consider other options.
Potential problems with a 529 rollover into a Roth IRA include:
Ownership Requirements
The 529 account you want to rollover needs to be at least 15 years old and it needs to have a consistent beneficiary throughout. Fifteen years is a long time and the option for a rollover has only recently become available. Some individuals just won’t be properly positioned to take advantage of this option because their accounts are not old enough.
Lifetime Aggregate Limit
Different investors have different financial situations. For some, a $35,000 limit won’t be a problem. But for others, it might be too small to accomplish their investment goals.
Annual Contribution Limits
Investors can only roll over so much into an IRA each year. For those with plenty of time to build their investment this limit won’t be a problem. But for those who want to create a more substantial investment over a shorter period, this limitation might be unnecessarily restrictive.
Making Informed Decisions for Your Financial Future
Having the option to roll over unused funds from a 529 plan to a Roth IRA gives investors a convenient way to utilize excess 529 contributions without incurring excess taxes and fees. It could be an excellent investment option if you meet the various requirements, including having a 529 plan that’s 15 years or older with a consistent beneficiary.
Contact MyStages® to schedule a comprehensive financial consultation to explore the potential of rolling over funds from your 529 plan to a Roth IRA.
