529 plans have long been trusted tools for families to save for their loved one’s education. With tax advantages and flexibility for qualified expenses, these plans help make higher education more affordable. However, many account holders have faced a lingering concern: what happens to leftover funds if a student’s education costs are lower than expected?
What’s Changing?
Effective this year, excess funds to be rolled into a Roth IRA for the plan’s beneficiary, thanks to the SECURE Act 2.0. Previously, if beneficiaries used 529 plan funds for anything other than qualified education expenses, the earnings portion of those withdrawals would be subject to income taxes and a 10% penalty. The new rule under SECURE Act 2.0 offers a tax-free alternative: rolling unused funds into a Roth IRA for the plan beneficiary.
Key Considerations and Limitations
While the new provision offers a great opportunity, there are some specific rules and limitations to keep in mind:
- 15-Year Rule for 529 Plans
- The 529 plan must be at least 15 years old to be eligible for Roth transfers.
- Contributions made in the last five years — and their earnings — are not eligible for a tax-free rollover.
- Lifetime Limit on Transfers
- The maximum amount that can be rolled over from a 529 plan to a Roth IRA is $35,000 per beneficiary, over their lifetime.
- Annual Contribution Limits Apply
- For 2024, Roth IRA contributions are capped at $7,000 per year (under age 50) or $8,000 (age 50+). This means rollovers must stay within those limits.
- Beneficiary Must Have Earned Income
- The beneficiary must have earned income equal to or greater than the rollover amount to qualify.
- Rules Still Evolving
- The Treasury Department has not yet issued complete guidelines on how providers should implement this provision. Availability and state-specific rules may vary.
- No Roth Conversions in the same year
- A 529 beneficiary cannot both use money from a 529 to fund a Roth and execute a Roth conversion in the same calendar year.
Can 529 Plan Owners Change the Beneficiary?
If you’re an account holder with excess funds, you might wonder if you can name yourself as the beneficiary to benefit from the Roth rollover provision. While technically possible, doing so could reset the 15-year clock for eligibility. Since the government has not yet clarified whether such changes restart the clock, it’s wise to proceed cautiously.
Tax Implications of the New Rule
The transfer of unused 529 funds to a Roth IRA is not subject to federal taxes, offering significant tax advantages for beneficiaries. By rolling over unused funds into a Roth IRA, beneficiaries can enjoy tax-free growth, avoiding the taxes and penalties associated with nonqualified withdrawals.
