The 529 Plan-to-Roth IRA Conversion Option

The 529 Plan-to-Roth IRA Conversion Option

January 02, 2024

Many parents with kids who have graduated college have been itching to take advantage of a unique provision in the Securing a Strong Retirement Act of 2022 (SECURE 2.0 Act). This benefit may enable these graduates to convert money originally meant to pay for their higher education costs into money to help them save for retirement.

The 529 College Savings Plan to Roth IRA rollover option

Starting this year, if college graduates have money leftover in their 529 College Savings Plan accounts, they may be able to transfer some or all of it into a Roth IRA without paying IRS penalties or federal income taxes.

How much? Up to $35,000 in total over their lifetime.

The fine print

Graduates can’t necessarily roll over all of this money all once. The maximum annual amount can’t exceed whatever the IRA maximum annual contribution amount is at the time (for 2024, the limit is $7,000).

If they have more than this amount in their 529 Plan account, they’ll have to make several rollovers over a multi-year period.

And if they’re making their own contributions to an IRA, the total combined amount can’t exceed the annual IRA limit.

For example, if they make a contribution of $4,000 to their traditional IRA in 2024, they can’t transfer more than $3,000 from their 529 Plan account to a Roth IRA that year.

One more potential limitation: IRA account holders must earn income each year, and their annual total Roth contributions can’t be more than what they’ve earned.

So, if a recent college graduate with a Roth IRA earns $4,000 in 2024 from a part-time job at Starbucks, their total mix of after-tax contributions and 529 Plan rollovers to that IRA must be $4,000 or less.  

On the flipside, if their salary is so high that they normally wouldn’t be able to make Roth IRA contributions, they can still transfer up to the annual limit from their 529 Plan to a Roth IRA tax-and-penalty-free.

Other rules and considerations

There are several hoops 529 Plan beneficiaries need to jump through to take advantage of this Roth IRA rollover opportunity:

  • Rollovers are only allowed for 529 Plan accounts that have been established for the original beneficiary for at least 15 years.
  • The beneficiary must be the owner of the Roth IRA.
  • Beneficiaries may not roll over any contributions made or earnings accrued over the five years preceding a rollover.
  • While qualified 529 Plan to Roth IRA rollovers won’t trigger federal taxes or penalties, they may be subject to state taxes.

Gaming the system?

Several people whose higher salaries disqualify them from normally making Roth IRA contributions have asked whether they can establish and contribute to a 529 Plan with themselves as beneficiaries this year, wait 15 years, and then start rolling that money over into a Roth IRA.

Other people have asked whether they can change the beneficiary of one of their kids’ 529 College Savings Plan accounts to themselves, wait 15 years, and then start moving that money into a Roth IRA.

I choose not to answer these questions for several reasons. One, I’m not a tax expert, and I suspect that the IRS is already aware that some high-income earners might try to use either strategy and will eventually impose rules to limit or close down these potential loopholes.

I also don’t answer because I believe these strategies violate the original intent of 529 College Savings Plans, which is to provide a tax-advantaged way for children and parents to help ease the financial burden of ever-rising higher education costs.

If these kids are lucky enough to have up to $35,000 remaining in their 529 Plan account after they graduate it’s a good thing that SECURE 2.0 Act will allow them to move that money into a Roth IRA.  

But, considering all of the moving parts in play, I recommend that any 529 Plan beneficiary who is considering taking advantage of this perk consult with a tax professional first.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax professional or lawyer.

 

 


This article was authored by David Jaeger and Jeffrey Briskin. David is a financial advisor at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or djaeger@canbyfinancial.com  Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.

 

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