529 Plan Conversion to Roth IRA

Historically, 529 plans - a tax advantaged education savings account - were considered a restrictive planning tool, limiting account holders to one of two options: usings funds solely for qualified educational expenses, or facing tax penalties for non-qualified withdrawals. However, the SECURE 2.0 Act, which took effect January 1, 2024, introduced more flexibility to 529 plans. 

Now, taxpayers have the option to rollover unused funds to a Roth IRA belonging to the beneficiary. To qualify for a Roth rollover, several stipulations must first be met: 

The 529 plan must be open for a minimum of 15 years before its funds are eligible to rollover to a Roth IRA; 

The funds within the 529 plan must have been contributed more than 5 years prior to rollover, as funds contributed within the last 5 years are disqualified from conversion; 

The Roth IRA must be owned by the same individual who is the beneficiary of the 529 plan; 

The annual Roth IRA contribution limits must still be adhered to, meaning that in 2025, no more than $7,000 can be converted from a 529 plan to a Roth IRA; and 

There is a lifetime rollover limitation of $35,000 per beneficiary. 

What options are available if excess funds remain in the 529 plan after covering educational expenses and rolling the $35,000 lifetime Roth IRA conversion limit? Account holders can: 

Change the beneficiary of the 529 plan to a qualified family member, which include the beneficiary's: spouse, child (including stepchildren, adopted children, and foster children), sibling, in-law, parents, aunt or uncle, niece or nephew, or a first cousin. 

If there are no beneficiaries that would benefit from the 529 plan, then either the account holder, beneficiary, or both may take out the remaining funds as non-qualified distributions. In doing so, the recipient of the withdrawal will be subject to income taxes and a 10% penalty on the earnings portion of the amount withdrawn. 

In the past, individuals chose not to fund 529 plans because the rules seemed complex and restrictive. For example, what if you started a 529 plan for your child who later decides not to attend college? What if all those tennis lessons paid off and your child gets a college scholarship, eliminating the need for the plan? What if your child decides to go to a less expensive school, leaving a substantial amount of funds in the 529? Such situations are examples of doubts that have historically dissuaded taxpayers from funding 529 plans, but due to the recent changes in tax law, no longer need to. 

The passage of the SECURE Act 2.0, and the less restrictive rules it brings, creates an exciting new opportunity for you to save sooner, allowing the funds more time to grow substantially, while still reaping the tax benefits. If you are interested in a 529 plan as part of your tax planning, please reach out to your trusted advisor at Pease Bell, CPAs for more information.