529 Plan to Roth IRA: Tax-Free Magic for Unused Education Savings

By Jonathan Thomas, Private Wealth Advisor

If you’ve saved diligently in a 529 college savings plan, a question might linger: “What if my child won’t need all those saved dollars for school?” Thanks to the SECURE 2.0 Act, passed in late 2022, you now have an option – roll over some of those unused funds into the tax-free powerhouse, the Roth IRA. This new maneuver boasts potential tax advantages, but it’s not a golden ticket without its own considerations. Let’s delve into the details.

Why is this a big deal?

Traditionally, tapping into unused 529 funds meant facing taxes and a hefty 10% penalty. This new option lets you sidestep those hefty charges and enjoy tax-free growth within your Roth IRA. Additionally, it bypasses income limitations for Roth IRA contributions, opening up a retirement avenue for those who might otherwise be ineligible. In 2024, income limitations for contributing to Roth IRAs are capped at $161,000 for single individuals and $240,000 for those married filing jointly.

But it’s not all sunshine and rainbows:

• 15-year rule: The 529 plan must be at least 15 years old to qualify.
• Annual limits: You can only convert up to the annual Roth IRA contribution limit ($7,000 in 2024, plus $1,000 catch-up for those over 50).
• Lifetime limits: There’s a $35,000 lifetime limit per beneficiary for 529 plan rollover contributions to Roth IRAs.
• Beneficiary ownership: The Roth IRA must be owned by the 529 plan’s beneficiary. They also need earned income at least equal to the rollover amount.
• Five-year rule: Contributions made within the past five years and their earnings are ineligible for the tax-free rollover.

Should you do it?

Before jumping in, carefully consider your situation:

• Do you truly need the college funds later? Prioritize education expenses first.
• Remember, 529 plans offer estate tax benefits. Unlike many assets, 529 plans are not included in your estate, potentially shielding them from the 40% federal estate tax (as of 2024) on estates exceeding $13.61 million. This could be an advantage for families passing assets to multiple generations.
• Tax laws constantly evolve. While this option exists today, future changes could alter or even remove it.

The bottom line:

529 plan conversions to Roth IRAs offer exciting flexibility and potential tax advantages. However, carefully weigh your options, including ensuring future education needs are met, considering potential estate tax benefits, and researching the risks of future changes in tax laws. Remember, informed decisions lead to a brighter financial future.

This post serves as a starting point. Do your research, understand the rules, and seek professional guidance if needed.

The information contained in this summary is for informational purposes only and any opinions expressed are current only as of the time made and are subject to change without notice. The information provided is not intended to be, and should not be construed as investment, legal or tax advice. Any investment advice provided by LVW Advisors is client specific based on each clients’ risk tolerance and investment objectives. This commentary is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.