In a significant change that gives families more flexibility in managing education savings, individuals will be able to roll over remaining funds from a 529 plan tax-free into a Roth IRA under a rule that goes into effect in 2022 and takes effect later this year.
As the academic year begins, it’s a good reminder that this provision can provide some peace of mind for families who may not use all of their 529 funds, according to a white paper from Seward & Kissel LLP titled “New Option: Rollover from 529 Account to Roth IRA.” The new setup allows savings to continue growing in a tax-efficient manner even after they’re no longer needed for education expenses.
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Before this rule was passed, the options for dealing with unused 529 account funds were limited. Individuals could either change the beneficiary to an eligible family member, withdraw up to $10,000 to pay off qualified student loans for the beneficiary or a sibling, or withdraw the funds for non-qualified purposes, which would subject them to taxes and a 10% penalty.
The new rollover option, which allows up to $35,000 to be transferred from a 529 account to a Roth individual retirement account, offers families a much more affordable alternative. It can also provide peace of mind for a growing tax-advantaged savings vehicle: According to insights from ISS Market Intelligence, which, like PLANADVISER, is part of ISS STOXX, 529 assets increased 5.7% in the first quarter of 2024 and 15.6% over the past year. Account balances also increased on average by 1% in the first quarter of 2024 and 3.1% over the past year.
According to the latest count from the Education Data Initiative, savings in 529 plans totaled $450.5 billion as of June 2023, representing an average account balance of $27,741.
Important requirements for rollover eligibility
However, to qualify for this tax-free transfer, several conditions must be met, attorneys said. First, the Roth IRA must be maintained for the benefit of the 529 account beneficiary. This ensures that the savings continue to benefit the original intended recipient. In addition, the 529 account must have been open for at least 15 years at the time of the transfer, which is a “15-year rule.”
Another important requirement is the “5-year rule,” which excludes all amounts contributed to the 529 account in the five years prior to the rollover, and any earnings on those contributions, from being rolled over to the Roth IRA. This rule prevents current contributions from being quickly rolled over into retirement savings.
The rollover amount is also subject to the Roth IRA’s annual contribution limits. For 2024, the maximum allowable contribution is $7,000 for those under age 50, and any rollover amount would be reduced by any direct contributions made to the Roth IRA or other individual retirement plan in the same year. In addition, the sum of rollover contributions and direct contributions cannot exceed the beneficiary’s earned income for that year.
There is also a lifetime limit on the amount that can be rolled over from a 529 account to a Roth IRA, which is set at $35,000. The transfer must be made via a trustee-to-trustee transfer between the 529 account and the Roth IRA to ensure compliance with the rule.
