Rolling Over Unused 529 Plan Funds into a Roth IRA

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education expenses. These plans are sponsored by a State or State Agency and come in two main types:

1. College Savings Plans: These plans work much like a 401(k) or IRA by investing contributions into mutual funds, ETFs, or similar investments. The account value could increase based on the performance of the chosen investments, but it also carries investment risk. The funds can be used at any eligible institution fora. wide range of qualified education expenses including tuition, fees, room and board, books, and supplies.
2. Prepaid Tuition Plans: These plans allow you to prepay future tuition at current prices at eligible public and private colleges and universities, which helps hedge against tuition inflation. Generally, funds can only be used for tuitions and fees, and the benefits are usually limited to participating schools within the sponsoring state or network.

Many states provide a state income tax deduction, up to a limit, for contributions made into an eligible 529 plan. Earnings in a 529 plan grow federal tax-free, and withdrawals are also tax-free when used for qualified education expenses. However, if you use the funds for non-qualified expenses, you could become subject to a 10% federal tax penalty along with income tax.²

Qualified education expenses typically include:

• Higher education tuition, fees, books, supplies, equipment, and room and board (if off-campus, expenses in excess of what the school housing would cost are not qualified)³,
• Education tuition up to $10,000 per year for tuition at private, public, or religious elementary or secondary schools⁴,
• Expenses associated with registered apprenticeship programs, including fees, books, supplies, and equipment, and
• Repaying student loans up to the $10,000 lifetime limit per beneficiary.

Rolling 529 plan funds into a Roth IRA can offer several benefits. By rolling the funds into a Roth IRA, the money can be used for retirement purposes without incurring penalties, which could offer greater flexibility if the funds are not needed for education and may align with the beneficiary's long-term financial needs. Starting retirement savings early can significantly benefit from compound interest over time. If a beneficiary has leftover 529 funds and meets the rollover conditions, transferring those funds to a Roth IRA could jumpstart their retirement savings and provide the benefit of tax-free growth. Additionally, if a 529 plan has more funds than needed for educational expenses, rolling over to a Roth IRA helps avoid the 10% penalty and income taxes on non-qualified distributions.

The IRS has identified specific requirements that must be met for this provision:

• There is a lifetime limit of $35,000 that can be transferred from a 529 plan to a Roth IRA.
• The 529 plan must have been open for at least 15 years.
• The amount to be transferred to a Roth IRA must come from contributions to the 529 plan (and earnings on those contributions) at least 5 years before the transfer date.
• The rollover can only be made to the Roth IRA of the beneficiary of the 529 plan.
• The rollover is subject to the beneficiary's annual Roth IRA contribution limit.⁵

In addition to the beneficiary of the 529 being the owner of the Roth IRA, that individual must have earned income that is at least equal to the amount that is rolled over.⁶ Also, because of the annual contribution limits, it can take multiple years to transfer all of the remaining 529 assets.

Along with Roth IRA rollovers, there are other options available for unused funds in a 529 plan. These plans are designed to be flexible, so you can make decisions based on your unique financial situation and goals.

One option you could exercise is to save for future education. If the original beneficiary might attend graduate school or other education programs in the future, you can keep the funds in the account for these expenses.

Another option is changing the beneficiary of the 529 plan. You can change the beneficiary of a 529 plan to another qualifying family member (including siblings or cousins) at any time without incurring taxes or penalties. However, it's important to note that it is unclear if changing the beneficiary on the 529 is permitted before rolling over to a Roth IRA or if the beneficiary change resets the 15-year holding period for the account.⁷

Additionally, you could consider using the funds for K-12 education. You can use up to $10,000 per year from a 529 plan to pay for tuition at K-12 private or religious schools. This allows you to utilize the funds before the beneficiary reaches college age. However, it's important to note that not every state offers an income tax deduction or credit for K-12 education expenses, which is important to keep in mind when determining how to use 529 funds.⁸

A final option is using the funds to pay off student loans. The IRS allows for up to $10,000 from a 529 plan to be used to repay the beneficiary's student loans, as long as the loans are considered qualified education loans.⁹ However, only 28 states have changed their plans to conform with this rule, so it's important to understand teh 529 plan rules in your state before exercising this option.¹⁰

By exploring these options, you can make informed decisions about how to best use or reallocate unused 529 plan funds, ensuring they contribute to you or your family's financial and educational goals.

This new provision offers 529 beneficiaries a boost for their futures in retirement. However, it's important to note that additional guidance from the IRS could alter how the legislation is interpreted. Always consider the tax and penalty implications of withdrawing funds, and consider consulting with a tax advisor or financial advisor to understand the specific impact based on your financial circumstances and goals.

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