529 Plan Funds Can Roll Over to Roth IRAs

529 plans are a popular way of saving for college. But options for using leftover funds have been limited.

However, provisions of the SECURE 2.0 Act that were passed in late 2022 and took effect on Jan. 1, 2024, allow you to consider rolling over up to $35,000 of unused money from a 529 plan to a Roth individual retirement account (IRA) for the plan beneficiary free of income tax or tax penalties.

Previously, the funds had to be used for qualified education expenses such as tuition, fees, books, room and board at an eligible education institution and tuition at elementary or secondary schools. However, you can now roll those unused funds into the 529 account beneficiary’s Roth IRA without facing a nonqualified withdrawal penalty.

529 plan contributions are after-tax and not deductible on your federal tax return. Some states, though, may allow a tax benefit.

About $450 billion was invested in more than 16 million 529 plan accounts nationally as of June 30, 2023, according to the College Savings Plans Network. While that is an impressive amount, parents and grandparents saving for a loved one’s education also realize that their high schoolers may decide that college is not for them, or that they may start yet not finish their degree. Nationwide, about one-third of undergraduates eventually drop out.

Planning Considerations for 2024 

Using leftover 529 plan money to fund a Roth IRA for your children or grandchildren can be highly beneficial to their future. If someone in their mid-20s were to put $35,000 in a Roth IRA and then leave it alone for 40 years, the account could accumulate to about $235,000 for them, assuming a 5% annual return.

The following guidelines must be met to be eligible for a rollover:

• The 529 plan must have been open for more than 15 years.
• Contributions and earnings on contributions from the last five years are not eligible to be rolled.
• Up to $35,000 per beneficiary can be rolled into a Roth IRA, but doing so will likely take five plus years because the amount per year cannot exceed the annual Roth contribution limit ($7,000 in 2024 if you are under age 50 and $8,000 if you are 50 or older).
• Income limits do not apply when rolling over funds from a 529 plan to a Roth IRA.

At first glance, it appears that the law provides significant flexibility in allowing up to $35,000 “per beneficiary,” thereby opening the possibility of multiple rollovers by changing the beneficiary each time. Account owners and their advisors will be watching whether Congress or the IRS provide further guidance.

Because of this, families with several children may choose to err on the side of caution and open a separate 529 account for each child, rather than one large 529. If the rule is later clarified to limit a rollover to one “per account,” it seems like each separate account would still qualify for the $35,000 rollover.

Alternatives for Leftover 529 Funds 

• Up to $10,000 can be used to pay off qualifying student loans.
• If the child receives a tax-free scholarship, parents can withdraw an equal amount out of the 529 plan account without incurring a 10% penalty (though the gains will be taxable).
• The money can be left in the account indefinitely and continue to grow tax deferred.
• The beneficiary can be changed to another individual who will use the funds for qualified education expenses, including yourself
• You can choose to withdraw the money, but doing so will incur tax penalties unless an exception applies, such as the beneficiary becomes disabled, or the beneficiary dies, and the withdrawal is paid to the beneficiary’s estate.

Talk to your AMG tax advisor to discuss how you could take advantage of this new opportunity.

Editor’s Note: This article was originally published JUNE 2023 and has been updated as of this post date.