Roth IRA rollovers: A fresh feature for 529 owners

Roth IRA rollovers: A fresh feature for 529 owners

The passing of the SECURE 2.0 Act turned 529 accounts into an even more valuable savings tool for families looking to give the gift of education to their loved ones. With the new regulations, 529 account owners can now, subject to certain limitations, roll over 529 funds to a beneficiary-owned Roth IRA without being subject to taxes or penalties.

Since they came into being in 1996, section 529 accounts have served as highly tax-efficient vehicles for funding a child’s education. Individual contributions to 529 accounts of up to $18,000 per year (or $36,000 per married couple) are not treated as taxable gifts to the beneficiary, the money in the account can grow tax-deferred, and some states even offer deductions on in-state plans. That said, the implications of possibly unused 529 assets is a source of uncertainty for some 529 account owners—particularly those who wonder what might happen to the funds if their loved one receives a scholarship, attends a less expensive school, or even decides to forego college altogether.

Fortunately, there is welcome news for families concerned about overfunding 529 accounts. The recently passed SECURE 2.0 Act now provides families the option to use leftover 529 funds to help kids save for retirement. More specifically, the Act includes a provision that, as of January 1, 2024, allows 529 account owners to transfer funds to a Roth IRA without incurring taxes or penalties. Previously, a 529 account owner or beneficiary who wanted to withdraw funds for any non-qualified education expense would be subject to income taxes and a 10% federal tax penalty on earnings.

This is an exciting development for families that adds to the list of reasons to save with 529 plans. The new feature, however, is subject to some limitations:

• Contribution limits: Rollover amounts cannot be greater than the annual Roth IRA contribution limit set by the IRS. In 2024, that amount is $7,000, plus an extra $1,000 catch-up allowance for individuals over the age of 50. The beneficiary must have earned income that is equal to a greater than the amount to be rolled over. There is also a $35,000 lifetime limit per beneficiary for rollover contributions to Roth IRAs.
• Holding periods: The 529 account holder must have owned the 529 for at least 15 years prior to executing a rollover. Furthermore, contributions made to the 529 account within the last 5 years are not eligible for the tax-free benefit.
• Ownership: For a tax- and penalty-free rollover, the 529 beneficiary and the owner of the Roth IRA must be the same person.

It is advisable to discuss your specific circumstances with a financial or tax professional before executing a rollover, as there are grey areas in the new statute that remain open to IRS interpretation. For example, it remains unclear whether a change of beneficiary in a 529 account—currently permissible at any time—will reset the 15-year holding period requirement. In addition, the state tax treatment of rollovers may vary from state to state.

Despite some of these limitations, families should feel encouraged that 529 plans continue to evolve in their favor, and that they now have more options to tax-efficiently support their loved ones, no matter what the future may bring.