Executive Summary:
- Overfunded 529 Plans can be rolled into a Roth IRA to jumpstart retirement savings.
- This can be a great strategy in certain situations, avoiding the 10% penalty on non-qualified distributions and receiving tax-free growth and withdrawals in retirement.
- However, there are complex rules to consider, like the 15-year account age requirement and the $35,000 lifetime rollover cap.
- In addition, the beneficiary must have earned income, and the rollover amount must stay within annual contribution limits.
- Lastly, changing the beneficiary may restart the 15-year clock, though the IRS has not released official guidance at the time of writing.
While 529 plans are often the best way to save for college expenses, many worry about over funding these accounts.
And it makes sense, because while a 529 plan is great for qualified education expenses (benefitting from tax-free growth and tax-free distributions), when used for other purposes, 529 distributions can incur unwanted taxes and penalties.
Of course, in a perfect world, savers would end up with the exact amount they need to fund their education expenses, but the reality is not so simple. Instead, many wind up with extra funds, opting for overfunding rather than underfunding their college needs.
Which raises the question: what should you do with the extra 529 funds?
Fortunately, you’ve got options: from simply withdrawing the funds and incurring taxes and penalties, to changing the beneficiary of the account to an eligible family member and funding their college needs.
And now, with the passage of SECURE 2.0 you’ve got another powerful option: Roll the funds into a Roth IRA for the beneficiary, helping them jumpstart their retirement savings.
In this article, we will explore the pros and cons of this approach and highlight the key rules and regulations to consider.
First, let’s look at the pros and cons of rolling unused 529 money into a Roth IRA.
Pros of Funding a Roth IRA with Unused 529 Money:
- Jumpstart retirement savings: Rolling unused 529 money into a Roth IRA can help the beneficiary get an early start on retirement savings.
- Avoid Penalties: By rolling funds into a Roth IRA, you can avoid the 10% penalty on non-qualified distributions.
- Tax benefits: Roth IRAs benefit from tax-free growth and tax-free distributions in retirement, making them a powerful investment account.
Ultimately, rolling unused 529 money into a Roth IRA can jumpstart retirement savings for the beneficiary, avoid the 10% penalty on non-qualified distributions, and offer tax benefits with tax-free growth and distributions in retirement.
Cons of Funding a Roth IRA with Unused 529 Money:
- Withdrawal Rules: While Roth IRAs are great for retirement savings, they do have certain withdrawal rules that can limit your ability to access funds penalty-free.
- Loss of control: With a 529 plan, you own the funds, no matter who the beneficiary is. Alternatively, if you contribute to a Roth IRA for your child or grandchild, they have full control over the account, assuming they have reached the age of majority.
- Complex rules: Lastly, there are several rules that you need to be aware of when rolling unused 529 money into a Roth IRA, which we will cover in detail below.
Ultimately, this can be a great strategy, but be aware of the cons: Roth IRAs have withdrawal rules that may limit penalty-free access to funds, you lose control of the funds once they are in the beneficiary’s account, and the process involves navigating complex rules and regulations.
Next, Here Are The Key Rules and Regulations When Rolling 529 Funds into a Roth IRA
Next, let’s explore the key rules and regulations for rolling 529 money into a Roth IRA. These guidelines are essential to ensure compliance and to maximize the benefits of this strategy.
- The 529 plan must have been open for a minimum of 15 years. (Important note: Changing the designated beneficiary of the 529 plan may restart the 15-year waiting period*.)
- The Roth IRA must be in the same name as the beneficiary of the 529 plan.
- The beneficiary must have earned income during the year the rollover is conducted.
- The beneficiary’s income must be below the annual limit for Roth IRA contributions.
- The rollover amount cannot exceed the annual contribution limit for IRAs.
- The amount rolled over cannot be more than the contributions made to the 529 plan, plus any earnings, within the last five years before the rollover.
- The total amount that can be transferred from 529 plans to Roth IRAs is capped at $35,000 per beneficiary.
- Contributions made to the 529 plan within the last five years are not eligible for rollover.
*The 529 industry submitted a letter to the IRS in September of 2023 to determine whether a change in beneficiary would reset the 15-year clock. That said, at the time of writing, the IRS hasn’t released official guidance on this issue, and it is unclear if or when they will.
The Bottom Line
In the end, rolling unused 529 money into a Roth IRA can be a powerful way to give your kids or grandkids a jumpstart on their retirement savings. But, like many complex strategies, it’s essential to be aware of the different rules and regulations to avoid running into issues. Consulting with a financial advisor can ensure you’re making the most of this opportunity while staying compliant. By strategically executing this strategy, you can provide a solid foundation for your loved ones’ financial future.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance. Additional information about Albion Financial Group is also available on the SEC’s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.