Roth IRAs May Be a Good Option for Your Leftover 529 Plan Savings

These plans are the most popular vehicle for education planning, with more than 16.25 million active 529 accounts nationwide as of June of 2023. 529 Plan savings totaled $450.5 billion for an average account balance of $27,741.¹ Clients can use the funds accrued within their 529 Plans to cover many different education-related expenses.

After a child or other relative’s education is fully funded or paid for, there are often ‘leftover’ funds remaining in the account. This can be a concern in terms of tax exposure. While the funds don’t expire, 529 plan account owners will pay a 10% penalty if they spend them on non-education expenses. The 10% penalty applies only to the earnings portion, though, and not to their original contributions.

Recently however, an additional option for these funds was created by Congress. In late 2022, the President signed into law a sweeping retirement bill known as SECURE ACT 2.0, which included a provision allowing qualifying “leftover” funds in a 529 account to be moved to a Roth IRA, penalty and tax-free. This provision, which became effective on January 1, 2024, has generated strong interest from investors of 529 accounts. While this tax law change expanded the flexibility of how 529 funds can be used tax-free, Congress included qualifications and limitations governing how, when, and how much can be transferred.

Here are some things you will need to know before discussing such a rollover with your advisor:

• There is a $35,000 lifetime cap on Roth IRA rollovers for each 529 account beneficiary.
• The Roth IRA account must be owned by the 529 beneficiary and they need to have been the beneficiary on the account for at least 15 years.
• The eligible rollover amount must have been in the 529 account for at least 5 years.
• The rollover amount is subject to annual Roth IRA contribution limits, which are based on the beneficiary's income, not the parents'.
• The beneficiary’s income in the year of the rollover must be at least equal to the amount of the rollover.
• Roth IRA income limits are waived for this type of contribution.

Note: The U.S. Treasury Department and IRS may issue future guidance interpreting these conditions. Any guidance could affect the tax treatment of 529 to Roth IRA rollovers.

You still have other options for leftover 529 funds besides Roth IRA rollovers. You can continue to keep the money invested in the account with the opportunity to grow tax-deferred until your child decides to attend college or graduate school in the future. There is no time limit on when funds must be withdrawn.

You can also transfer the savings to another eligible family member, such as a sibling or even yourself to use for higher education. Of course, you can still withdraw the money and use it however you like. But you will need to pay taxes on any earnings, plus a 10% penalty of those earnings. Some exceptions are allowed on the penalty regarding scholarships granted or the disability of the beneficiary.

Conclusion

Managing the leftover funds in your 529 account can be a complex issue. There are a number of considerations as to whether you would be best served by moving funds from your 529 account to a Roth IRA. These new rules increase 529 plan flexibility, giving families another reason to save for college without worrying about a beneficiary not attending college.

Your financial planner can help you understand your options and weigh the pros and cons so you can make a decision that aligns with your family’s financial goals. There is no deadline to move these funds and we expect to have more information and guidance before April 15, 2025 (the 2024 Roth funding deadline). If you have questions on whether a Roth IRA conversion is right for your situation, please feel free to reach out.

¹ Education Data Initiative June 30, 2024 https://educationdata.org/college-savings-statistics#:~:text=There%20were%2016.25%20million%20active,balance%20of%20%2430%2C652%20in%202021