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[Prefer to listen? You can find a podcast version of this article here: E212: Can a 529 Be Rolled Into a Roth IRA?]

A 529 College Savings account can be a great way to save for college. It has tax advantages, it can be invested, and it's specifically designed for education.

But one concern many parents have is related to a "what if" scenario: what if your child doesn't attend college? Or what if you have funds left over after college is paid for?

One option is to update the beneficiary to another child. Another option is to simply withdraw the money and live with the fact that you'll pay taxes and penalties on the growth (not the end of the world).

But thanks to SECURE ACT 2.0, there is another option: a rollover into a Roth IRA.

How a 529 works

First, let's talk about how a 529 works.

A 529 account, often referred to as a 529 plan, is a tax-advantaged savings plan designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these plans are sponsored by states, state agencies, or educational institutions.

Contributors can invest in a variety of mutual funds or similar investment vehicles. The account value fluctuates based on the performance of the chosen investments.

Contributions grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses, including tuition, room and board, books, and other required equipment. Recently, this has been expanded to include K-12 tuition expenses, up to a certain amount per year.

These plans are highly flexible in terms of where the beneficiary can use the funds, covering expenses at any accredited college, university, vocational school, or other post-secondary educational institutions in the United States and even some international institutions.

Many states also offer tax deductions for contributions and a few even offer tax credits.

How a Roth IRA works

Now let's talk about the Roth IRA.

A Roth IRA is a retirement savings account that offers tax-free growth and tax-free withdrawals in retirement, under certain conditions. Contributions are made with after-tax dollars, meaning you don't get a tax deduction when you contribute, but you benefit from tax-free withdrawals later on.

The Roth IRA has annual contribution limits, with income limits affecting eligibility.

Contributions and earnings can be withdrawn tax-free in retirement, provided the account has been open for at least five years and you're at least 59½ years old.

There are no required minimum distributions during your lifetime, offering estate planning benefits.

You can withdraw your contributions (not earnings) at any time without taxes or penalties, offering financial flexibility.

Roth IRAs are ideal for those who expect to be in a higher tax bracket in retirement or who value the flexibility and tax benefits for their retirement savings. Roth IRAs are especially attractive for younger people because of the long time horizon for tax-free growth.

Rolling a 529 to a Roth IRA

Due to a new provision in SECURE Act 2.0 (which is a law passed in 2022 focused on enhancing retirement accounts), you now have the option of rolling over a limited portion of a 529 to a Roth IRA in the name of the beneficiary tax and penalty free.

Here are the rules:

• The lifetime maximum for rollovers is $35,000 per beneficiary.
• To utilize the option of transferring funds from a 529 plan to a Roth IRA, the 529 account must have been established for at least 15 years. Furthermore, contributions to the 529 made in the last five years, along with their earnings, cannot be moved to a Roth IRA.
• The transfer of funds from a 529 to a Roth IRA adheres to the annual Roth IRA contribution cap, set at $7,000 for the year 2024, with a maximum transfer limit of $35,000 across one's lifetime. Therefore, to transfer the total of $35,000, it would need to be spread out across multiple years.
• Moreover, the individual receiving the Roth IRA must be the same as the beneficiary of the 529 plan.
• For the process of moving funds from a 529 plan to a Roth IRA to be successful, the recipient needs to have an income from work. The maximum amount that can be transferred is either equal to the recipient's annual income or the Roth IRA's yearly contribution limit, whichever is lower. For instance, if the recipient's income for a year is $3,000, then only $3,000 from the 529 can be shifted to the Roth IRA. Without any earned income, the transfer cannot proceed.
• A rollover is not subject to Roth IRA income limits. 529 funds can be rolled to the beneficiary's Roth IRA regardless of income.
• The annual Roth IRA contribution limits count both regular contributions and 529 rollovers in aggregate. So if the beneficiary maxes out a Roth IRA for the year, 529 funds cannot be rolled over that year.
• You cannot move money back to the 529 once a rollover is complete.'
• The rollover must be direct to the Roth IRA, meaning the check gets sent directly to the custodian (which is the institution holding the account) for the Roth IRA.
• If the beneficiary changes, it will reset the 15-year clock.

How to roll over a 529 to a Roth IRA

If you're a parent wondering how to actually do this, the good news is that it's a fairly simple process.

Step one is to contact the plan provider for the 529 account and ask for the rollover form. Many state plans have the form on their websites so you can start there.

You will then complete the rollover form and submit it to the 529 custodian. A check will be issued directly to the Roth IRA of the beneficiary.

You’ll need to make sure you have these moves documented in the event of an IRS audit, so a 1099-Q will be generated for the funds distributed from the 529 plan, and Form 5498 will be received from the Roth contributions. Keep these documents and provide them to your tax preparer.

Is a 529 to Roth IRA rollover right for you?

Does a 529 to Roth IRA rollover make sense for you and your child? Here's when it might be worth considering:

• You have extra funds in the 529
• Your child does not plan to attend college or has finished college and is not likely to go back to school (at least not in the short term).
• You have no other college-bound children (or other eligible beneficiaries that you want to use it for).
• Your child has earned income and is therefore eligible for a Roth IRA contribution.
• You don't like the idea of paying taxes and penalties on the growth and you want to give your child a head start on retirement savings.

In this scenario, a 529 to Roth IRA rollover can be a great way to use extra 529 funds in a tax-efficient way that benefits your child.