Converting Excess 529 Plan Account Funds to a Roth IRA

A 529 plan account is a tax-efficient way to save for a child’s or grandchild’s education costs.  529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.  529 plan accounts have multiple tax advantages, including allowing an individual to contribute up to $18,000 per year, or $36,000 per married couple.  These contributions are considered gifts to the beneficiary of the account but are not taxable because they qualify for the so-called “annual exclusion” from taxable gifts.  The investments in the 529 plan grow tax-deferred, and withdrawals are not subject to income tax when used for qualified educational expenses.

Considering the high cost of education today, it may seem unlikely that any assets in a 529 plan account would go unused.  However, if an account’s beneficiary decides not to attend college, attends a more affordable school, or receives a significant scholarship or financial aid, it is possible there would be funds remaining in the 529 account when the beneficiary’s education is concluded.  Withdrawals from 529 accounts that are not used for qualified educational expenses are subject to income tax and excise tax of 10% on the earnings portion of the withdrawals.  Certain exceptions to the 10% penalty apply.  To avoid the income and excise taxes, account holders have the option to change the beneficiary of the 529 account to an eligible relative of the original beneficiary, such as a sibling, child, or other descendant.  Beginning in January of 2024, another option that avoids the income and excise taxes is to roll over the amount remaining in the 529 account to a Roth IRA.  Whereas amounts withdrawn from 529 accounts may only be used for qualified educational expenses, withdrawals from Roth IRAs do not have restrictions on their use.

In the Setting Every Community Up for Retirement Enhancement Act 2.0 (“SECURE 2.0”) enacted by Congress at the end of 2022, it is now possible to roll over 529 plan account assets to a Roth IRA in the name of the account beneficiary, free of income and excise taxes.

There are several requirements to consider before proceeding with a rollover:

• First, the 529 plan account must have been in existence for at least 15 years.
• A rollover may only be made to the Roth IRA of the 529 account beneficiary.
• The maximum lifetime amount that can be rolled over from a 529 account to a Roth IRA is $35,000.
• The annual rollover from a 529 account cannot exceed the annual Roth IRA contribution limit ($7,000 for 2024 or $8,000 if the beneficiary is over age 50).  As a result, moving $35,000 to a Roth IRA could take over five years to complete.
• Contributions to the 529 plan made within the previous five years (including earning on such contributions) are ineligible to be transferred to the Roth IRA.
• Rollovers are not subject to the typical income limitations to contribute to a Roth IRA.  As an example, if a beneficiary’s income exceeds $153,000 (the income limitation for a single filer), the beneficiary could not contribute to a Roth IRA but could still roll over funds from a 529 account to a Roth IRA.
• Finally, the beneficiary of a 529 plan will need to have compensation at least equal to the amount being rolled over during the years the 529 to Roth rollovers are taking place.

The ability to roll over excess assets in a 529 plan account to a Roth IRA is a powerful way to convert savings for a beneficiary’s education to retirement savings and should be considered an option whenever a 529 account holds more assets than the beneficiary requires for educational expenses.  Further guidance from the IRS is expected to clarify the legislation allowing such rollovers, and therefore it is advisable to consult with your estate planning attorney and other tax advisors before commencing a plan to transfer 529 account balances to Roth IRAs.