Starting in 2024, there will be a new way to transfer funds out of your 529 education accounts. Now you won’t have to pay taxes and incur withdrawal penalties on the earnings.
529 Education Accounts Can Rollover to Roth IRA Accounts
Good news! 529 education accounts will now allow limited rollovers to Roth IRA accounts. This applies to the beneficiary of the 529 account. This change was a part of the SECURE Act 2.0 that was within the Consolidated Appropriations Act signed near the end of 2022. This allows for new college savings planning strategies of 529 accounts for your children or grandchildren.
Avoid Penalties – Rules You Must Follow to Rollover Your 529 Account Money to a Roth IRA
- The owner of the Roth IRA receiving the funds must be the beneficiary of the 529 account.
- The 529 education account must have been open for at least 15 years before rollovers to Roth IRA accounts can take place.
- Contributions and any associated growth must remain inside the 529 account for at least 5 years before they are eligible to rollover to a Roth IRA.
- There is a lifetime rollover limit of $35,000 per beneficiary.
- Annual 529 to Roth IRA rollover amounts are subject to the annual combined Traditional IRA/Roth IRA contribution limits.
- 529 account rollovers to Roth IRA accounts are combined with the beneficiary’s IRA/Roth IRA contribution limits. This could lower or possibly eliminate the amount the 529 beneficiaries can contribute for that year to their Traditional IRA or Roth IRA.
- The 529 account beneficiary must have earned income at least equal to the amount rolled over.
- The income limits for Roth IRA contributions do not apply for rollovers from 529 accounts.
Contributions made to a child’s 529 education account that are not used for education expenses will be able to transfer to a Roth IRA account — penalty and tax-free. This will allow families to give the next generation a jump start on retirement savings. Contributions made at a child’s birth could have the potential to grow tax-free for 65 years or more!
529 Strategies You Can Implement To Grow Tax-Free Savings
Leftover College Savings Funds
Your child or grandchild may still have funds remaining inside their 529 education account after they finish school. This change will allow you to direct the leftover funds towards their retirement. Rollovers from their education savings account to a Roth IRA would provide a jumpstart for retirement savings. The jumpstart happens when the graduate enters the workforce and may have other goals such as buying a home. Saving for a downpayment on a house could be taking funds away from retirement savings.
Hypothetical scenario of how 529 account rollovers could work:
Jennifer recently graduated from college and started an entry-level job in her desired field. She was able to graduate college debt free. Her current income allows her to begin contributing to her company’s 401(k). However, this is only enough to get the full matching contributions from her employer. There is not enough room in the budget to begin funding a Roth IRA from her income. Jennifer just turned 23 years old, and her parents have a 529 education account with a $35,000 balance remaining after paying her education costs. The 529 account was opened when Jennifer was born.
The family decides to make $5,000 annual rollovers from Jennifer’s 529 account to a Roth IRA in her name starting at age 23. When Jennifer turns 30 years old, a total of $35,000 has been rolled over from her 529 account to her Roth IRA. Assuming Jennifer can earn an 8% annual return on the investments with her Roth IRA, Jennifer’s Roth IRA would be worth $48,183.14 at age 30. Assuming Jennifer makes no additional contributions and continues to earn 8% per year on the money rolled into her Roth IRA until age 65, $35,000 in rollovers could be worth as much as $712,404.29! That is all tax-free income from the Roth IRA that would be available to Jennifer as she approaches retirement.
Child does not need 529 funds
This scenario works much like the leftover college savings funds strategy described for Jennifer. The main difference is that the rollovers from the 529 account start when Jennifer reaches age 18. This could be due to Jennifer receiving a large scholarship for her college tuition or any other reason that college expenses will not use up the funds inside Jennifer’s 529 account. This scenario assumes that Jennifer has at least $5,000 earned income annually from age 18 through age 25.
The family decides to begin rolling over $5,000 annually when Jennifer is 18 years old. This is because they are certain she will not need all the 529 account funds to pay for education. By the time Jennifer is 25, a total of $35,000 has been rolled over from her 529 account to her Roth IRA. Assuming Jennifer can earn an 8% annual return on the investments with her Roth IRA, Jennifer’s Roth IRA would be worth $48,183.14 at age 25 in this scenario.
The rollovers from the 529 account to Jennifer’s Roth IRA would be worth $1,046,756 when she reaches age 65 with no additional contributions if she can earn an average annual 8% return on the funds that were rolled out of the 529 account!
529 Education Account – What You Should Do Now
This change for 529 education accounts makes contributions an even more attractive choice for families to help their children or grandchildren save for the future. The beneficiary of the 529 education account will be able to use the funds tax-free to further his or her education. If there are funds remaining in the 529 education account, you can help your children or grandchildren get a jump start on retirement savings by rolling over funds into a Roth IRA. There is more flexibility than ever before to avoid paying taxes and withdrawal penalties from 529 education accounts.
You should consider this rule change carefully when determining the contributions you want to make to 529 accounts for your children and grandchildren. The additional flexibility for tax-free distribution options may make 529 education accounts more popular in the future.
If you have 529 accounts for your children or grandchildren, and they are either finished with school or will not be using the funds for education, you can now roll over the money into a Roth IRA. This will allow the funds to grow tax-free for future retirement savings.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Hypothetical examples listed above are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
