Roth IRA rollovers: Unlocking new potential for 529 accounts

Roth IRA rollovers: unlocking new potential for 529 accounts

The SECURE 2.0 Act has introduced an innovate benefit, making 529 accounts an even more versatile tool for families. As of January 1, 2024, 529 account owners can roll over unused funds into a beneficiary-owned Roth IRA, tax- and penalty-free, subject to certain limitations.

Before diving into the specifics of Roth IRA rollovers, it’s worth noting why holding onto your CollegeBound 529 account can also be a smart move. Beyond funding undergraduate education, 529 accounts can be used for graduate school, repaying student loans, or even saving for grandchildren by transferring the account to a new beneficiary. This adaptability allows your investment to support your family’s evolving needs over time.

Understanding the new rollover option

Since their introduction in 1996, 529 accounts have been a cornerstone of tax-efficient education savings. Individual contributions of up to $19,000 per year (or $38,000 per married couple) are considered non-taxable gifts to the beneficiary. The funds grow tax-deferred, and some states even offer tax deductions for contributions to in-state plans.

However, families often worry about what happens to unused funds. What if a beneficiary gets a scholarship, attends a less expensive school, or chooses not to pursue higher education? The SECURE 2.0 Act provides a solution by allowing unused 529 funds to be transferred into a Roth IRA, giving beneficiaries a jump start on saving for retirement. Previously, withdrawing unused funds for non-qualified expenses resulted in income taxes and a 10% federal penalty on earnings.

This feature significantly enhances the value of 529 plans and encourages families to continue saving without fear of wasted funds.

Important considerations

While the new rollover provision is a game-changer, there are important rules to keep in mind:

• Contribution limits: Rollovers are capped at the annual Roth IRA contribution limit, which in 2025 is $7,000, with an additional $1,000 catch-up allowance for individuals aged 50 or older. The beneficiary must have earned income equal to or greater than the rollover amount, and there is a $35,000 lifetime cap per beneficiary for these rollovers.
• Holding period: The 529 account must have been open for at least 15 years. Contributions made within the last five years are not eligible for rollover.
• Same beneficiary: The 529 beneficiary and the Roth IRA owner must be the same person to qualify for the tax- and penalty-free transfer.

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.

Why you shouldn’t worry about unused 529 funds

One of the biggest hesitations families have about 529 accounts is the possibility of overfunding. In addition to the Roth IRA rollover benefit, here are some other reasons why those concerns are largely unfounded:

• Graduate school and advanced education: If your child continues their education, the funds can be used to cover tuition and other qualified expenses.
• Loan repayment: Up to $10,000 from a 529 plan can be applied to student loan debt, helping reduce financial burdens.
• Generational planning: Leftover funds don’t have to go to waste. You can transfer the account to a grandchild or another family member, helping to ensure the benefits extend across generations.

A brighter future for 529 savings

The recent enhancements to 529 plans make them more versatile and valuable than ever. Whether you’re saving for education, addressing student loans, or planning for generational wealth, these accounts offer unparalleled flexibility to meet your family’s needs.