529 accounts are an established way to help kids and other family members save for college. And now it turns out you might be able to use leftover 529 funds to help them save for retirement as well.
At least, that's the idea behind a new provision included in the SECURE 2.0 Act. It works like this: Starting in 2024, you can roll unused 529 assets—up to a lifetime limit of $35,000—into the account beneficiary's Roth IRA, without incurring the usual 10% penalty for nonqualified withdrawals or generating any taxable income.
This might come as a relief to anyone worried about having excess funds stuck in a 529 should the intended beneficiary not need them (say, if they opted not to attend college or chose a lower-cost school).
But could this provision prove to be something more? Could a savvy investor consider intentionally overfunding a 529 with an eye toward eventually building up tax-free Roth savings, either for themselves or members of their family?
Don't count on this being the case, says Chris Kawashima, a senior research analyst at the Schwab Center for Financial Research.
"This provision offers another option for those wondering what to do with unused 529 assets," he says. "Funding a Roth isn't the primary selling point."
The rules—at least the ones we know so far—could make rollovers an appealing possibility for leftover funds. However, more complex maneuvering could be more trouble than it's worth, as we'll see below.
What are the limits?
Before anyone starts roping off $35,000 in their 529 accounts, it's important to understand the limitations on this type of rollover:
- Holding periods. You need to have owned the 529 for at least 15 years before you can execute a rollover. Contributions made to the 529 plan in the last five years before distributions start—including the associated earnings—are ineligible for a tax-free rollover.
- Annual limits. Your rollover can't exceed the annual Roth contribution limit, which in 2023 is $6,500. So, if you wanted to roll over the entire $35,000 lifetime limit amount, you would have to do so over six years under the current contribution limits. (Though, the Roth contribution limit could rise in the future, allowing you to do larger rollovers.)
- Ownership. The beneficiary of the 529 plan must also be the owner of the Roth IRA, and they must have earned income at least equal to the amount of the rollover.
These are just the rules included in the legislation. It's possible the IRS could interpret the law differently when it comes time to implement it. And much remains uncertain: For example, although 529s allow you to change beneficiaries whenever you want, it's not clear whether such a change will be permitted before a rollover, or if changing beneficiaries could trigger a brand new 15 year holding period. Nor is it clear who would be responsible for any penalties should a rollover fall afoul of the rules.
That's not to say you shouldn't consider taking advantage of this new provision if you find yourself with unused 529 assets.
What you can do
Here are some things to discuss with a planning professional before queuing up a rollover:
- If you already have a 529 plan, don't change anything yet. Nothing can be done until 2024, and much remains to be clarified. If you're thinking about making yourself the beneficiary of that 529 to get around Roth IRA contribution rules, you should wait until we get final rules about the lifetime contribution amount and 15-year holding period. Switching the designated beneficiary may not make any sense.
- If you're planning to open a 529 for your children, consider funding different accounts for each child—but don't assume you'll also be able to transform these assets into Roth assets with a future rollover. Without additional clarity from the IRS on how the 15-year rule will work, it is better to err on the side of caution. If it turns out that you can switch 529 beneficiaries without having to wait 15 years for a rollover, you can always adjust your funding strategy.
- Consider opening a Roth IRA for the beneficiary. Regardless of how the IRS interprets the law, you could still take this opportunity to contribute to a child's Roth IRA if they have earnings. This will get them started on their retirement savings at a time when their personal income tax rate is likely to be low. And it's more efficient to contribute directly instead of taking a detour into a 529.
- If you're concerned about the assets in an overfunded a 529 plan, you already have other options. As noted, parents can switch designated beneficiaries at any time and continue using a 529 account for qualifying educational purposes. Plus, up to $10,000 of 529 plan funds can be used to pay off qualifying student loans. Finally, if the child earns a tax-free scholarship, parents can take an equivalent amount out of the 529 plan without the 10% penalty (though the earnings portion of the distributions will be taxable).
Overall, this new provision gives savers another way to put their 529 assets to work. But it's probably best to treat a 529-to-Roth rollover as a potential backup option, rather than a retirement-saving strategy unto itself.