529-to-Roth Rollovers: What You Need to Know
By Zeke Anders on June 20, 2024
Perhaps one of the most exciting updates in the SECURE Act 2.0 was the creation of 529-to-Roth rollovers. Savers have long used 529 accounts to save for college, but a common concern was that the beneficiary would not use all of the funds in the account. Qualified withdrawals from 529 accounts are tax-free, which is a great benefit for those saving for college. However, non-qualified withdrawals are subject to income tax and a 10% penalty on earnings. This penalty keeps some people from using 529 accounts altogether, or at least limiting what they contribute. By creating a 529-to-Roth rollover option, Congress helped to alleviate some of those concerns. That said, the process is not straightforward. There are several limitations on this strategy that are important to know.
The first requirement is that the 529 account must be open for 15 years. An open question is whether it must have the same beneficiary for 15 years. Next, you can only roll over up to the annual Roth contribution limit each year. In 2024, the contribution limit is $7,000 for those under age 50, $8,000 for those age 50 or older. Unlike with normal Roth contributions, income phase-out limits do not apply. Even if the beneficiary earns too much to directly contribute to a Roth, they can still roll 529 funds into a Roth up to the annual limit. However, a beneficiary must have some earned income to do the rollover. If a beneficiary only had $2,000 in earned income, for example, only $2,000 could be converted from the 529 into a Roth. The Roth account must be in the name of the beneficiary, which goes back to open question above. If the 529 must have the same beneficiary for 15 years, you could not change the beneficiary, to yourself for example, to contribute to your own Roth IRA. If the 529 account just has to be open for 15 years, then maybe you could. Consider, though, that a Roth IRA for a child or grandchild may have a much longer time to grow tax-free. Additionally, there is a $35,000 lifetime limit on rollovers. In other words, you’d have to convert $7,000 per year for 5 years, and then you could not convert additional dollars to the Roth IRA for that beneficiary. Earnings and contributions must stay in the account for 5 years before being rolled over, as well.
As you can see, this strategy has a number of caveats and restrictions. It might not make sense to fund a 529 with the intention of converting the funds to a Roth IRA later. That said, if you have 529 funds that will not be used, this is a valid strategy for putting those funds to better use, potentially, and avoiding taxes and penalties on some or all of the earnings. Another strategy is to use the funds for another beneficiary such as another child or a grandchild, or even yourself. If your beneficiary received a scholarship, withdrawals up to the scholarship amount will be subject to taxes but no penalty. 529 funds can now be used for certain K-12 expenses in many states too. If you have questions, please reach out to us.
Source: https://www.irs.gov/publications/p590a as of June 20, 2024
