Many families turn to 529 plans to save for education, but what happens if the account is overfunded? What if your child earned scholarships that covered tuition? What if they chose a field that does not require a four-year degree? You’ve diligently saved for years, only to be left with an unused education account. One option is to take the funds out of the 529, resulting in a 10% penalty on the earnings portion of the account (there are certain exceptions). However, when the SECURE Act 2.0 passed in 2022, Congress provided a solution for overfunded 529 plans, a “Qualified tuition program rollover to a Roth IRA” or 529 to Roth rollover. Let’s dive into how it works.
How does the 529-to-Roth rollover work?
A 529 beneficiary can roll over amounts to their Roth IRA, subject to the annual contribution limit ($7,000), up to a maximum lifetime amount of $35,000. There are several restrictions to navigate:
- Earned Income: The beneficiary must have earned income each year of a distribution.
- Rule of 15: The 529 account must be open for more than 15 years prior to taking this action.
- Rule of 5: Contributions made within the 5 years preceding the rollout and the corresponding earnings are not eligible. Another reason why multiple years are needed to get full funding.
Rules and limitations apply! There are complexities with this rule that we help our clients navigate. For example, not all state income tax programs are in sync with the federal government thus further adding to the complexity.
Benefits of a Roth IRA
This type of account helps kick start your child’s retirement savings. Withdrawals (including earnings) from their Roth would be tax free after age 59½. If they need funds before then, there are circumstances that allow taking funds out early without penalty.
Another feature of a Roth IRA is that the child can STILL use the account to fund qualified education expenses. If your child chooses to go back to school after the 529-to-Roth rollover, those funds are still available to the child for that purpose.
If you have funds left over in the 529 plan after meeting the lifetime max for the 529-to-Roth rollover, the remaining funds can still be taken out by the account owner for that 10% earnings penalty OR you can change the account beneficiary.
- According to the IRS, “there are no tax consequences if you change the designated beneficiary to another member of the family…So, for example, you can roll funds from the 529 for a sibling’s 529 plan without penalty.”
- The list of eligible family members is surprisingly long – we can help you determine who qualifies.
529 to Roth IRA Can Be Complex
These rules can be challenging to interpret for anyone not in the financial planning industry, and mistakes can lead to a “gotcha” moment if you slip up.
Reaching the lifetime maximum of $35,000 with the 529-to-Roth strategy is a multi-year project. At FCA Corp, we can help parents and young adults determine whether a rollover makes sense and help determine what funding amounts are eligible each year.
If you are considering a 529 plan for your child, know that the advantages are clear. The 529-to-Roth strategy can make these accounts even more attractive, by helping your child build a foundation for the future through both their education and tax-advantaged savings.
Contact FCA Corp for Help
Does it make sense for your unique situation? Contact the FCA team to find out. Our team, which includes professionals with credentials such as CFP®, CPA, MBA, and JD, is ready to navigate clients through this complex education and retirement strategy.
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