Section 529 Plans (529s) are a popular vehicle for parents and grandparents to save for college tuition. The combination of relatively high contribution limits, wide eligibility, tax incentives, and the variety of plans and providers to choose from is a big part of the appeal for many savers.
But with college cost being difficult to predict[1], the question of what to do with potential “left over” balances has become more pressing for some.
Read: 5 College Savings Options for Your Child
Balances in 529s that remain after a beneficiary has completed their education aren’t necessarily lost forever. The balance could remain in the account and be used for education expenses later in the account beneficiary’s life, like graduate school for example.
The account could also be set up to benefit a close family member like a sibling or child of the account’s original beneficiary.
But congress has seen fit to add another option for savers to consider, a Rollover to a Roth IRA.
Read: Do I Need an IRA?
While the ability to use 529 funds to seed a Roth IRA is attractive, there are rules and limitations to consider before proceeding.
Before we go any further, it’s important to be clear on one point.
I do not recommend overfunding a 529 plan with the aim of assuring a remaining balance for the purposes of seeding a Roth IRA. I also do not recommend setting up a 529 plan for the sole purpose of using it to get funds into a Roth IRA.
Consider this option only if you happen to have left over balances that can’t otherwise be used.
Read: Should I Do a Roth IRA Conversion?
Also, there are two parties to keep in mind here.
One is the owner of the Section 529 Plan. This is often a parent or grandparent. The other is the beneficiary of the 529, which is also the owner of the Roth IRA that would receive rollovers from the 529.
Now let’s talk rules!
529 to Roth IRA Rule #1: Ownership
The person named as the beneficiary on the Section 529 plan must also be the owner of the Roth IRA receiving the rollover.
So, if you opened a 529 for your child and have a balance remaining, any rollovers to a Roth IRA must be made to a Roth IRA in the child’s name.
529 to Roth IRA Rule #2: Timing
The Section 529 Plan from which the rollover comes, must have been open for at least 15 years prior to the date of the rollover.
For example, if you opened a 529 for your child in 2010, you would not be eligible to rollover to a Roth IRA until at least 2025.
Further, contributions (and earnings on those contributions) made in the five-year period prior to the rollover are ineligible to be rolled over to a Roth IRA.
Finally, it is unclear who is responsible for tracking Roth IRA rollovers so account owners who undertake this strategy should plan to keep meticulous records.
The timing rules leave more than a few unanswered questions and 529 owners will need to wait and see if the IRS clarifies.
529 to Roth IRA Rule #3: Dollar Limits
In other Rollover transactions, an account owner is typically permitted to rollover as many or as few of their eligible dollars as they please. Not so with a 529 to Roth IRA Rollover.
The maximum rollover from a 529 to a Roth IRA in any year is subject to the same limit as Roth IRA contributions for that year.
For example, if a Section 529 plan owner wanted to rollover a portion the plan balance to a Roth IRA in the name of the 529’s beneficiary in 2024, that rollover would be capped at $7,000.
And there is a lifetime limit on these rollover transactions. Over their lifetime, a beneficiary may only rollover up to $35,000 from a Section 529 Plan to a Roth IRA.
Finally, completing a maximum annual 529 to Roth IRA Rollover will bar the Roth IRA owner from making a direct contribution to any Roth IRA or Traditional IRA for that same tax year.
For example, if on January 15, 2024, the 529 owner executes a rollover to a Roth IRA owned by the 529 beneficiary in the amount of $7,000; the Roth IRA owner will not be eligible to contribute to any Roth IRA Traditional IRA until 2025.
Conversely, if the Roth IRA owner makes a $7,000 contribution for tax year 2024 to their Roth IRA or Traditional IRA, they would not be eligible to convert any balances from a 529 for their benefit in 2024.
Think of it this way; a 529 to Roth IRA Rollover is treated much like a direct Roth IRA contribution with respect to annual contribution limits.
529 to Roth IRA Rule #4: Trustee-to-Trustee
A Section 529 to Roth IRA Rollover must be a trustee-to-trustee transfer.
That is, the funds must be transmitted directly from the 529 to the Roth IRA. This typically means that the Section 529 Plan custodian would send a check payable to the Roth IRA custodian.
If a 529 owner or beneficiary takes possession of a plan distribution – say by receiving a check payable to them – that amount would no loner be eligible to be treated like a rolled over.
529 to Roth IRA Rule #5: Income Requirement
The 529 beneficiary/Roth IRA owner, must have earned income at least equal to the amount of the rollover in the year of the rollover.
For example, if the 529 owner executes a $7,000 rollover for 2024, the 529 beneficiary/Roth IRA owner, must have at least $7,000 income from employment during 2024 to qualify for the rollover.
The good news is that there is no cap on the income that can be earned by the Roth IRA owner in the year of the rollover.
While we don’t have perfect and complete information, this is still a valuable option for 529 owners and beneficiaries. Remember to consult your tax professional for all tax related questions and your Financial Advisor for how this maneuver fits into your Financial Plan.
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[1] The cost difference between an in-state public college, out-of-state public college, and private college can be substantial and that makes knowing the “right” amount to save difficult.
JG2024-0918