February 27, 2023

Last week we covered some major changes resulting from the new SECURE ACT 2.0 law. Now I’d like to dive deeper into one of the specific provisions – allowing rollovers from 529 college funds to Roth individual retirement accounts (IRAs) (I also did a Tip of the Day on this topic for my radio show – you can listen here).

Popular 529 plans, which are offered in nearly every state, provide great opportunities to help save for college during kids’ early years. Accounts are usually owned by parents, who name their children as beneficiaries. The plans are funded with after-tax money that’s then invested in mutual funds or exchange-traded funds. Earnings grow tax-free and the money can be used tax-free on qualified educational expenses when the child is older.

Let’s say a grandparent contributed $25,000 to a 529 account for their one-year-old grandchild. Fast forward 17 years, and the account is worth $75,000. However, the child isn’t going to attend college (or earned a scholarship to pay for everything).

What do you do?

If you withdraw the funds and don’t use them for education, the earnings are subject to taxes and a 10% penalty. Thus, the risk of unused funds causes many parents to fund 529s conservatively or not at all.

Starting in 2024, the SECURE ACT 2.0 allows tax-free retirement rollovers from 529 plans. Beneficiaries of 529 plans (i.e., children and grandchildren) can do a tax-free rollover of up to $35,000 to a Roth IRA. As usual, the devil is in the details.

The $35,000 cap is a lifetime maximum. The Roth IRA must be owned by the 529 beneficiary, not the owner. Perhaps most importantly, the 529 account must be open for a minimum of 15 years. It’s unclear yet whether that waiting period is required when a 529 plan beneficiary is changed or if prior years count.

Importantly, any rollovers are subject to annual Roth IRA contribution limits (the 2023 limit is $6,500). So, if the $35,000 lifetime limit is hit, it will take years.

Like the many other changes in the SECURE ACT 2.0 legislation, this is a positive for savers. But minding the details is crucial – follow the rules or you’ll pay penalties. If your family is exploring a 529 rollover, make sure to get expert help.