529 to Roth IRA

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If you have a 529 plan that exceeds what was needed for education costs, there may be a way to roll it over into a Roth IRA. Laura Saunders explains in The Wall Street Journal:

It happens more than you think, given the spiraling costs of college: People who save money for a child’s education expenses in tax-favored 529 plans wind up with leftover dollars in them. Perhaps the student got a scholarship or chose a lower-cost school—or even took a different path in life.

Now there’s a new way to tackle this problem. A law that took effect this year allows unused 529 funds to be transferred to Roth IRAs tax-free, up to certain limits. Often this move will cost less than simply withdrawing extra funds, which could bring taxes and a penalty.

Roth IRA sponsors, including Fidelity Investments, Vanguard Group, and Charles Schwab, are ready for these rollovers and have posted forms for them on their websites. While the Internal Revenue Service still needs to clarify some issues, many 529 owners aren’t affected and can proceed.

Saunders continues with some basic facts about the transfers:

First, it’s important to know that 529-to-Roth rollovers are meant to be a modest solution to a modest problem; they aren’t a boondoggle. In general, Congress has plugged potential loopholes.

As a result, these rollovers come with key limits. To be eligible, a 529 account must have been open at least 15 years, and rollovers cannot be contributions added in the last five years. The rolled-over funds also must go directly from the 529 plan into a Roth IRA owned by the beneficiary.

In addition, 529-to-Roth IRA rollovers cannot exceed a total of $35,000 per beneficiary, although it’s unclear how this will be tracked. However, someone who owns several 529 accounts—say for different children or grandchildren—could have a $35,000 rollover limit for each one.

Rollover recipients also face other requirements that generally apply to Roth IRAs. Each recipient must have at least as much earned income as the rollover—so a beneficiary whose pay is $4,000 in a year could only qualify for a $4,000 rollover of 529 funds.

Normal contribution limits also apply. For 2024, total Roth contributions can’t exceed $7,000 per saver under age 50. So if a 529 owner rolls $5,000 of account funds into a Roth IRA for an eligible child under 50 this year, then the child can only put up to $2,000 more into a Roth IRA.

But here’s a welcome difference: The income limits for making Roth IRA contributions don’t apply to recipients of 529 rollovers. This will allow a broader range of savers to benefit, because normally they must have modified adjusted gross income below $146,000 (single filers) or $230,000 (joint filers) in order to make full contributions directly to Roth IRAs in 2024.

529 owners considering Roth rollovers should also check state law. Some states impose a tax on the rollovers if the dollars received a tax break going in, while others don’t. With federal taxes, contributions to 529 plans and Roth IRAs are both in after-tax dollars.

Action Line: If you’re rolling a 529 over into a Roth IRA for your student, be sure they download my Special Report: How To Invest After Graduating College for what they need to know to get a good start. And when you’re ready to talk about your own portfolio, I’m here.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West (RIP JB) and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.

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