College Savings Plans: 529 to Roth IRA Transfer

College Savings Plans: 529 to Roth IRA Transfer

529 College plans are non-taxable savings plans that are designed to encourage saving for higher education expenses. These plans allow individuals to contribute funds that can grow tax-free and be withdrawn without incurring federal taxes, provided they are used for qualified educational expenses, such as tuition, fees, books, and certain room and board costs. However, if a Section 529 plan was overfunded, it can result in a large sum of money set aside for education, but with no beneficiary to use the funds. Any use of the funds in a 529 plan for nonqualified purposes will generate federal income tax and a 10 percent penalty on the earnings attributable to a nonqualified withdrawal. There may also be similar taxes and penalties applicable at the state level. Fortunately, there was a recent update to the rule that will allow a 529-to-Roth transfer.  The Roth IRA account would grow tax free and future withdrawal of principal and income could be withdrawn tax free as long as Roth IRA rules are followed.

An Update to Legislation Allows 529 to Roth IRA Transfer.

Based on the new update to section 126 of SECURE 2.0 Act of 2022, a special ruling has been introduced to allow nontaxable transfers from 529 plans to Roth IRA’s. This allows unused college funds to be transferred to a beneficiary’s retirement savings, without being subject to income tax and tax penalties. This rule will go into effect in 2024.

Benefits of the New Rule:

  • It alleviates concerns about unforeseen taxation, allowing families to maximize the time value of money by investing for tax-free growth on college savings as early as possible.
  • The new rule enables greater flexibility in saving for the educational needs of children by removing the need to predict exactly how much a child will require to pay for their future schooling.

Limitations to the Rule for 529 to Roth IRA Transfer:

  • The lifetime maximum a 529 beneficiary can transfer under the rule is $35,000.
  • The 529 account needs to be in existence for at least 15 years.
  • No contributions or earnings on contributions from the last five years can be transferred.
  • The transfers are subject to annual Roth IRA contribution limits (but there is no upper income constraint).

This new ruling allows for transfers to beneficiary’s Roth IRA accounts, not owners account and the transfer needs to be properly processed.  The best option is a trustee-to-trustee transfer where neither the owner nor the beneficiary ever has possession of the funds.

If you have questions regarding the transfer of funds from a 529 college savings plan to a Roth IRA or are in need of assistance, contact our expert accountants at The Innovative CPA Group.

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2023-10-25T14:00:02+00:00August 9th, 2023|IRAs & 401ks, Retirement|

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