There’s a new rule in place that makes 529 plans an even more attractive way to save for your child’s education. Starting this year, unused funds in a 529 plan can be transferred into a Roth IRA.
As a result, parents don’t have to worry as much about having leftover funds in a 529 plan if their child doesn’t attend or finish college, earns a scholarship, picks a less expensive school than expected, or otherwise doesn’t need all the money saved over the year in a 529 plan.
However, there are a number of requirements, restrictions, and limitations to the new 529-to-Roth IRA transfer rules. And if you mess up and don’t follow the rules, you could end up with a big tax bill and be hit with a hefty IRS penalty.
But don’t worry … keep reading to learn all the ins and outs of the new 529 plan-to-Roth IRA rollovers. I’ll also provide some basic information about 529 plans and Roth IRAs, as well as offer a few additional options if you have unused funds in a 529 account.
529 Plan Basics
To fully understand the 529-to-Roth IRA rollover rules, you need to be familiar with some basic information about 529 plans.
These plans are used to save for a designated beneficiary’s education expenses. You can only have one beneficiary for each 529 plan account, so parents with more than one child will need to open a separate account for each kid.
There are no federal tax breaks when you put money in a 529 plan (although a state income tax deduction or credit might be available). However, that money grows tax-free, and no federal income taxes are due when you withdraw funds from a 529 plan if the money is used for qualified education expenses, such as:
- Tuition, fees, books, supplies, and equipment for college
- Room and board for students attending college on at least a half-time basis
- Computers, software, and internet access used by a college student
- Fees, books, supplies, and equipment for an apprenticeship program
- Up to $10,000 of student loan payments owed by the 529 plan beneficiary or the beneficiary’s sibling
- Up to $10,000 of tuition at an eligible elementary and secondary school
If money taken out of a 529 plan is used for a non-qualified expense, any earnings withdrawn from the account are taxed at the same federal tax rates as wages, tips, and other “ordinary” income. In addition, a 10% penalty generally applies to funds used for a non-qualified expense (although there are some exceptions).
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Roth IRA Basics
Knowing a bit about Roth IRAs, which are tax-advantaged retirement savings accounts, will also help you determine if a 529-to-Roth IRA rollover is your best option if you have leftover funds in a 529 account.
First, it’s important to realize that you don’t get a federal income tax deduction when you put money in a Roth IRA (as you do when you contribute to a traditional IRA). However, you can withdraw Roth IRA contributions at any time without paying additional taxes or facing a penalty. Earnings in the account can be withdrawn tax- and penalty-free once you’re 59½ years old as long as you’ve had a Roth IRA for at least five years.
If you take money out of a Roth IRA before turning 59½, you’ll usually owe income taxes on the withdrawn earnings and could also be hit with a 10% penalty (again, there are exceptions to the rule).
In addition, annual IRA contribution limits restrict how much you can put in a Roth IRA each year. For 2024, the most you can put in a Roth IRA is $7,000 if you’re under 50 years old at the end of the year. If you’re 50 or older by Dec. 31, 2024, you can put in an additional $1,000 in “catch-up” contributions for the year.
WealthUp Tip: The annual contribution limits apply to the combined total of contributions to all your IRAs—both traditional and Roth IRAs. For example, if you’re under 50 and put $2,000 in a traditional IRA in 2024, the most you can put in a Roth IRA for the tax year is $5,000.
The annual IRA contribution limit is gradually reduced to zero if your income is within a certain range. For 2024, the contribution limit is phased out if your modified adjusted gross income for the year is within the following Roth IRA income limits:
- $230,000 to $240,000 if your filing status is married filing jointly or surviving spouse
- $146,000 to $161,000 if your filing status is single, head of household, or married filing separately and you didn’t live with your spouse at any time during the year
- $0 to $10,000 or more if your filing status is married filing separately and you lived with your spouse at any time during the year
Your IRA contributions for the year also can’t exceed your “earned income” for the year. So, for example, if you only have $3,000 of earned income during the year, that’s all you can contribute to one or more IRAs that year.
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Requirements for 529 Plan-to-Roth IRA Rollovers
Now let’s take a look at the specific requirements and limitations for transferring unused funds from a 529 plan to a Roth IRA. They dictate how long the 529 account must be opened, how much can be rolled over to a Roth IRA, how the transfer is structured, and more.
If the rules aren’t followed, the amount rolled over from a 529 plan to a Roth IRA will be treated as a distribution used for non-qualified expenses. That means the earnings portion of the distribution will be subject to federal income tax and an additional 10% penalty. So, it’s very important to know the rules in advance before attempting a 529-to-Roth IRA rollover.
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Funds Must Be Transferred to Beneficiary’s Roth IRA
Unused funds in a 529 plan can’t be transferred to just anybody’s Roth IRA. They have to be rolled over into a Roth IRA owned by the 529 account beneficiary.
So, for instance, parents can’t pull money out of their child’s 529 account and put it in their own Roth IRA. In that case, it must go into a Roth IRA set up for the child.
WealthUp Tip: Parents can open a custodial Roth IRA for a child. With a custodial account, the parent can manage the account until the child reaches the age of majority. Unused funds from a 529 account set up for the child can be rolled over into the custodial Roth IRA.
Trustee-to-Trustee Transfer Required
A 529 plan-to-Roth IRA rollover must be handled as a direct trustee-to-trustee transfer. In other words, the 529 plan administrator must send the leftover money directly to the bank or financial institution that opened the Roth IRA for the 529 account beneficiary.
You can’t “touch” the transferred funds yourself at any time during the rollover process. So, for example, you can’t personally take money out of a 529 plan (e.g., receive a check in your name) and then turn around and deposit the money into a Roth IRA.
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529 Plan Must Be Open for 15 Years
You can’t set up a 529 account and then quickly transfer funds in the account to a Roth IRA. The 529 plan must be open for at least 15 years before you can transfer money from the account to a Roth IRA.
This helps ensure that 529 accounts are opened and funded to actually save for education expenses—not for retirement. After 15 years, you might realize that money in the 529 account won’t be needed for qualified education expenses and can then initiate a 529-to-Roth IRA transfer. But the 15-year requirement forces you to wait years before making that determination.
Transferred Amounts Must Be In 529 Plan at Least Five Years
You can’t roll over contributions (and earnings attributable to those contributions) made within the last five years. Instead, an eligible rollover amount must have been in the beneficiary’s 529 account for at least five years.
As with the 15-year rule described earlier, this prevents quick transfers of 529 funds to a Roth IRA and encourages saving for the cost of an education.
Limits on the Amount That Can Be Rolled Over
There are two separate limits on how much you can roll over from a 529 account to a Roth IRA account—an annual limit and a lifetime limit.
The annual limit on rollovers from a 529 plan to a Roth IRA is the same as the annual IRA contribution limits noted earlier. So, for example, no more than $7,000 can be transferred from a 529 account to a Roth IRA in 2024 if the 529 account beneficiary is under 50 years old.
The Roth IRA income limits don’t apply to the annual limit on transfers from a 529 plan to a Roth IRA. However, you still can’t transfer more than the 529 account beneficiary’s earned income for the year, and the annual contribution limits still apply to the combined total of contributions to all the beneficiary’s IRAs.
The lifetime limit on the amount that can be transferred from the beneficiary’s 529 account to a Roth IRA is $35,000. So, once you’ve transferred a combined total of $35,000, no more can be rolled over from a 529 plan to a Roth IRA.
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Other Options For Unused 529 Plan Funds
What if you don’t want to transfer unused funds in a 529 account to a Roth IRA? Of course, you can withdraw the money and spend it on non-qualified education expenses. For instance, if you need the money for a down payment on a house, that money might come in handy. However, you’ll probably have to pay taxes and penalties on the earnings associated with those funds.
If you want to avoid taxes and penalties, there are basically four other things you can do with leftover money in a 529 plan.
Transfer Unused 529 Funds to a Family Member’s 529 Plan
Leftover 529 plan funds can be transferred to a family member’s 529 account without triggering any taxes or penalties. You can also simply change the beneficiary to a member of the original beneficiary’s family.
However, taxes and penalties will still be due if the money eventually is used for something other than qualifying educational expenses.
Transfer Unused 529 Funds to a Family Member’s ABLE Account
Excess funds in a 529 plan can also be moved to a family member’s ABLE account, which is a savings account for people with disabilities.
However, if you’re transferring money from a 529 plan to an ABLE account, make sure you don’t exceed the ABLE account’s annual contribution limit.
Pay Student Loan Debt With Unused 529 Funds
As noted earlier, money in a 529 plan can be used to pay up to $10,000 of a beneficiary’s student loan debt. It can also be used to pay up to $10,000 of student loan debt owed by the beneficiary’s sibling.
The $10,000 cap is a lifetime limit, not an annual one. It’s also a per beneficiary limit, not a per account limit. Payment of a sibling’s student loan counts against the sibling’s lifetime limit, not the beneficiary’s limit.
WealthUp Tip: The student loan interest deduction is reduced by the amount of student loan interest paid with tax-free earnings withdrawn from a 529 account. However, the deduction isn’t impacted by interest paid with 529 account contributions.
Leave Unused 529 Funds In Your Account
Since there’s no time limit on using money in a 529 plan, you can always leave excess funds in a 529 plan account to use in the future. The beneficiary might eventually decide to take additional courses, attend graduate school, or even pass the leftover funds on to children of their own.
