529 to Roth IRA Rollovers: New Rules, New Opportunities
As a trusted CERTIFIED FINANCIAL PLANNER™, my mission at Columbus Street Financial Planning is to help you navigate the ever-changing landscape of investment vehicles and tax laws to make the most of your hard-earned money. That’s why I’m excited to share the details of a monumental change in the world of education and retirement savings: the new rules allowing rollovers from 529 plans to Roth IRAs.
The SECURE 2.0 Act, signed into law in December 2022, includes a provision that will allow tax and penalty-free rollovers from 529 college savings plans to Roth IRA retirement accounts starting in 2024. This is a major shift that effectively allows 529 plans to serve as both education and retirement savings vehicles, providing much-needed flexibility to families saving for their children’s future.
Why is this a big deal? Let’s dive in.
The Pre-SECURE 2.0 Landscape
Before the SECURE 2.0 Act, families who saved in a 529 plan and didn’t end up using all the funds for qualified education expenses faced a difficult choice. They could either:
- Keep the funds in the 529 plan for a future grandchild’s education (which isn’t always feasible or desirable) or
- Take a non-qualified withdrawal and pay income tax plus a 10% penalty on the earnings portion of the withdrawal.
This “use it or lose it” nature of 529 plans caused many families anxiety. Many worried about overfunding their 529 accounts and being penalized if their child chose a different path than college.
The New 529 to Roth IRA Rollover Option
Starting January 1, 2024, the game changes. Under the new rules, 529 plan account owners can roll over funds from a 529 account to the beneficiary’s Roth IRA, tax and penalty-free. This rollover option opens up a world of possibilities.
Here’s how it works:
- Rollovers are subject to the annual Roth IRA contribution limit. For 2024, that limit is $7,000 (with an additional $1,000 catch-up for those over 50).
- There is a lifetime rollover limit of $35,000 per 529 plan beneficiary.
- To qualify for a tax and penalty-free rollover, the 529 account must have been open for at least 15 years.
- Rollovers cannot include contributions (or earnings on contributions) made within the last 5 years.
Here's an example of how this might work:
Let’s say you’ve been diligently saving in a 529 plan for your daughter, Emma, since she was born. The account has been open for over 15 years and has a balance of $100,000. Emma decides to attend a public in-state university, and you end up using only $70,000 of the 529 funds for her education.
Under the old rules, you’d have to either keep the remaining $30,000 in the 529 plan for a future grandchild or pay taxes and penalties to withdraw it.
Under the new rules, starting in 2024, you could roll over $7,000 per year (Emma’s annual Roth IRA contribution limit) from the 529 plan to Emma’s Roth IRA. You could do this for four years, rolling over a total of $28,000, before hitting Emma’s $35,000 lifetime rollover limit.
Why is this powerful? That $28,000 rolled over when Emma is 22 could grow to over $2,000,000 by the time she’s 65, assuming a 9% annual return. And all of those gains could be withdrawn tax-free in retirement. That’s the power of compounding and starting to save for retirement at a young age.
State Tax Implications
While the federal rules around 529 to Roth IRA rollovers are now clear, things are a bit murkier at the state level. In Ohio, contributions to the state’s 529 plan, CollegeAdvantage, are deductible from state income tax up to $4,000 per year per beneficiary. Withdrawals from Ohio’s 529 plan used for qualified higher education expenses are also exempt from state income tax. However, rollovers from an Ohio 529 plan to a Roth IRA would likely be considered a non-qualified withdrawal, subjecting the earnings portion to Ohio state income tax and a 10% penalty.
Before initiating a 529 to Roth rollover from an Ohio 529 account, be sure to consult with a qualified tax professional on the state tax implications and whether Ohio conforms to the new federal rollover rules. While beneficial for federal taxes, the 529 to Roth rollover may still trigger state tax consequences in Ohio.
Is a 529 to Roth Rollover Right for You?
While the new rollover option is a powerful tool, it’s not right for everyone. Here are a few things to consider:
- Timing: If your child is still in school, it’s probably best to wait until their education is complete before considering a rollover. You don’t want to roll over funds you might need for future education expenses.
- Other financial priorities: For young adults just starting their careers, paying off high-interest debt or saving for a home down payment might take precedence over funding a Roth IRA. Consider your child’s overall financial picture before initiating a rollover.
- Alternative uses of 529 funds: In some cases, it might make more sense to keep leftover 529 funds in the plan for a future grandchild or even take a non-qualified withdrawal. Work with your financial advisor to weigh your options.
The Bottom Line
The new 529 to Roth IRA rollover rules are a game changer for families saving for education. They provide much-needed flexibility and a powerful new way to jumpstart a child’s retirement savings.
However, like any financial strategy, 529 to Roth rollovers need to be considered in the context of your overall financial picture. State tax implications need to be navigated carefully.
At Columbus Street Financial Planning, we’re here to help guide you through these decisions. We’ll work with you to understand your unique goals and craft a personalized plan to help you make the most of tools like 529 plans and Roth IRAs.
If you have any questions about the new rollover rules or want to discuss your education and retirement savings strategy, please don’t hesitate to reach out. We’re here to be your trusted partner on the path to financial success.
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