I had been listening to the Talking Real Money Podcast. The recent Episode titled Stocks Start Strong, from April 3rd there was a listener that had asked the question about how to convert an old 529 Education Savings Account to Roth IRA. This comes up from time to time on other podcasts, or in conversation. I wanted to make sure we help those understanding the New 529 to IRA Conversion Rule with a Simplified Guide.
People may now think, oh if my kids don’t use their 529 Plan, they can now just convert it to an IRA. Well, Let’s get down to some of the specifics because there are some rules and qualifying criteria.
Starting in 2024, there is a significant change that will allow people to convert their unused 529 education savings into a Roth IRA for the account’s beneficiary. This is aimed at enhancing the flexibility and utility of 529 plans and Roth IRAs. Here I’ll try and break down all the crazy rules and limitations for the new 529 to Roth IRA Conversion.
What Has Changed
Historically, 529 plans were primarily used for educational expenses, with few options for leftover funds. The introduction of this rule offers a tax- and penalty-free way to roll over up to $35,000 from a 529 plan into a Roth IRA for the same beneficiary. This approach not only avoids the typical penalties of 10% associated with non-qualified withdrawals but also opens up a new avenue for retirement savings.
There Are Rules and Limitations
Lifetime Limit: This is one many don’t think of, however, a maximum of $35,000 can be rolled over from a 529 plan to a Roth IRA across the beneficiary’s lifetime. Yes. lifetime.
Contribution Caps: The rollover amount is subject to the Roth IRA’s annual contribution limits, which are $7,000 for individuals under 50 and $8,000 for those 50 or older in 2024. This means you can’t transfer the entire $35,000 at once; it would need to be spread across multiple years.
Earnings Requirement: The beneficiary needs to have earned income at least equal to the rollover amount in the year of the transfer.
15-Year Rule: This is another rule that often get’s overlooked. The 529 plan must have been established for at least 15 years before funds can be rolled over to a Roth IRA.
Five-Year Contribution Rule: Funds to be rolled over cannot include contributions (and their earnings) made within the last five years.
Income Limits Waived: Normally, Roth IRAs have income limits for contributions. However, these limits do not apply to the rollover from a 529 plan.
Qualifying Criteria
- The Roth IRA into which funds are rolled must be owned by the 529 plan’s beneficiary.
- The money transferred must have been in the account for at least five years.
- The amount transferred can’t exceed your balance from previous five years.
- Each rollover contribution must also adhere to the Roth IRA’s annual contribution limits.
Here is an Example
Imagine a beneficiary named Scotty with $30,000 in a 529 plan, deciding not to pursue further education and opting instead to become an Amazon Reseller. Previously, using these funds for non-educational purposes would incur crazy taxes and penalties. Now, Scotty’s parents can gradually transfer these funds into a Roth IRA for Scotty, helping him jumpstart his retirement savings without any tax penalty.
Important Considerations
While this new rule opens up promising opportunities for maximizing the use of 529 plans, it’s essential to plan strategically. Given the annual contribution limits and the prerequisites for a rollover, it might take several years to fully transfer the $35,000 limit into a Roth IRA. Furthermore, the specifics of the rule, such as state tax implications and the precise process for rolling over funds, may vary and require consultation with a financial advisor.
This rule represents a notable shift in how families can plan for education and retirement, offering a safety net for 529 plan funds that might otherwise go unused. It underscores the importance of financial planning and adaptability in using available tools to secure a stable financial future.
As always, like we said earlier, please consult with you investment and tax professionals regarding a 529 Educational Savings Plan, and any Roth IRA Conversion. Horns Up! \m/ \m/
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