Starting in 2024, qualified unused money in long-held 529 plans can be rolled over into a Roth IRA without incurring tax penalties.
That’s great news! Or is it? In today’s post, I’ll run through the details, pros, and cons of the new 529 plan rollover rules.
What are the new 529 plan rollover rules?
The Secure 2.0 Act, which was signed into law in 2022, created new rules to allow unused money from a 529 account to be rolled over into a Roth IRA without incurring tax penalties. These new rules went into effect January 1, 2024.
The idea behind this is that if people know they won’t incur tax penalties for withdrawing leftover 529 money, then they are more likely to save money in a 529 account. The hope is that this change will eliminate the feeling that money is “trapped” in a 529 account if it ends up not being needed for education expenses.
Of course, there are several conditions that apply to 529-to-Roth IRA rollovers in order to avoid the tax penalties:
- The 529 account must have been open for more than 15 years,
- Beneficiaries can only rollover a total of $35,000 during their lifetime,
- The beneficiary of the 529 plan and the Roth IRA must be the same person,
- The annual Roth IRA contribution limits still apply, and
- Money contributed to the 529 plan within the last five years–plus earnings on that money–can’t be included in the rollover.
What are the pros to the new 529 rollover rules?
If you are hesitant to place money in a 529 account because you don’t know how much–if any–will be needed for your student’s future, the new rollover rule should alleviate some of that hesitancy. This leaves you free to look into taking advantage of any incentives your state’s 529 plan offers.
Obviously, if your beneficiary’s needs change in the future and the money in the 529 account is no longer needed for education expenses, then the new 529 rollover rules give you a way to move that money into a Roth IRA while still avoiding tax penalties. So you’ll still be setting your beneficiary up for a bright future, but just in a different type of account.
What are the cons to the new 529 rollover rules?
The cons to the new 529-to-Roth IRA rollover rules can be summed up in one word: limits. Although the new rule is offering flexibility that didn’t exist before, you’re still limited on how much can be transferred per year and over the beneficiary’s lifetime.
An important limit to consider is the annual IRA contribution limit. Because although you can currently contribute up to $7,000 per year to an IRA (and that number will likely increase over time), it will take five years of contributions at that maximum amount to reach the $35,000 lifetime limit.
In other words, you’ll have five years of not contributing “new” money to an IRA. So when rolling over from your 529 account to your IRA account, you’re essentially losing time and potential investment into your retirement account.
How does changing beneficiaries on a 529 plan affect the rollover rules?
It’s possible to change the beneficiary on a 529 plan, but the IRS hasn’t published guidance yet about whether updating the beneficiary will affect the requirement that the account has to be open for 15 years prior to transferring funds to a Roth IRA.
In other words, we don’t know yet if the 15 year holding period starts over when a new beneficiary is named.
What else can I do with unused 529 money?
Rather than transferring unused 529 plan money into a retirement account, you do have a few options to use the money without incurring additional penalties and fees:
- The easiest option is to switch the plan to another beneficiary.
- You can also use the money to pay off up to $10,000 in qualifying student loans, which could be done after changing the beneficiary on the account.
- Additionally, if the 529 plan’s beneficiary earns a tax-free scholarship, you can withdraw that scholarship amount from the plan without a tax penalty. However, you will have to pay tax on any gains that you withdraw.
Abridged by Amy
Saving in a 529 plan is a smart, tax-advantaged option that you should absolutely capitalize on to help your family prepare for future expenses and potentially lower your tax bill at the same time.
The new 529 plan rollover-to-Roth IRA rules do provide a good option for any unused money in a 529 plan. However, you should weigh the costs and benefits of using your annual Roth IRA contribution limit this way and work with an accountant to determine the course of action that will lead to the most tax savings.
