Can I Roll Leftover 529 Funds Into a Roth IRA?

New Rules for 529 Rollovers

The SECURE 2.0 Act of 2022 ushered in many rule changes for tax-advantaged accounts like 529 college savings plans and individual retirement accounts (IRAs). Among its provisions are new rules allowing unused 529 funds to be rolled over into a Roth IRA. These are the basic rules:

• The Roth must be opened in the name of the plan’s beneficiary (typically the student).
• Rollovers have a lifetime cap of $35,000.
• Rollover contributions are subject to annual Roth IRA contribution limits ($6,500 or your earned income, whichever is less, in 2023).
• The 529 account must be open prior to the rollover for at least 15 years to qualify.
• Funds must have been in the 529 account for at least five years before being rolled over.

Contributions to 529 accounts are not deductible on your federal taxes. However, earnings and withdrawals are tax-free as long as the money is used for qualified education expenses, including certain college tuition and living expenses, graduate school, vocational education, apprenticeships and K-12 tuition. A portion of non-qualified withdrawals may be subject to a 10% penalty as well as federal income taxes on earnings.

Rolling unused 529 funds into a Roth isn’t the only option. You can also keep funds in a 529 indefinitely to cover future educational expenses, like graduate school or vocational training. Unused 529 funds can be designated for another beneficiary, which may be handy if you have another child headed to school. The new Roth IRA rollover is an additional option that lets families sidestep taxes and penalties—and create a forward-looking financial benefit that rewards beneficiaries for spending less than anticipated on college.

Advantages of Roth IRAs for Young Savers

The tax advantages of a Roth IRA can be especially helpful for young savers. Contributions to a Roth IRA are not tax-deductible, but Roth IRAs have tax benefits that pay off over the long term.

• Investments grow tax-free while the money is in the account. Any dividends, interest, capital gains or appreciation are excluded from taxable income.
• Qualified withdrawals are also tax-free. By contrast, withdrawals from traditional IRAs and 401(k)s are taxable as regular income.
• Rules for withdrawal are more forgiving than with traditional IRAs:
  • You may withdraw rollover contributions (not earnings) any time after five years without penalty.
  • You may use up to $10,000 toward the purchase of a first-time home.
  • You may take penalty-free early distributions if you are disabled.
  • You do not have to take required minimum distributions in retirement.

These tax benefits are helpful at any age, but young savers have more time before retirement for tax savings to help maximize growth. Say you roll $35,000 into a Roth IRA by the time you’re 27 years old (at $6,500 per year, it would take six years). Assuming a 7% annual return and a 22% tax rate, you would have $524,106 upon retirement at age 67, compared to $293,480 if you invested the same amount in a taxable account. Better still, qualified withdrawals are tax-free, so none of your Roth money needs to be allocated for taxes in retirement.

How to Do a Roth IRA Rollover From a 529 Plan

Although the IRS is still ironing out details, rolling 529 funds into a Roth IRA will likely involve a few simple steps:

1. Open a Roth IRA Account

Roth IRAs are available through online and traditional brokerages, mutual fund companies and financial institutions like banks and credit unions. Your 529 provider may offer Roth IRAs, in which case you may be able to transfer the money internally and save yourself a few administrative steps.

2. Transfer Money

Follow IRS guidelines when they’re available. According to SECURE 2.0, funds must be rolled over in a direct trustee-to-trustee transfer. Contact your 529 and Roth IRA provider(s) for directions on doing a direct transfer and keep records of your transactions in case the IRS has questions.

3. Invest Your Funds

Once your funds have settled, make sure your rollover Roth IRA is invested properly. You can choose your own investments; find mutual funds, exchange-traded funds or target-date funds that fit your needs; or work with an advisor or robo-advisor to get the right mix of investments for you.

The Bottom Line

Having the option of rolling leftover 529 funds into a Roth IRA may alleviate some worry about contributing too much to a college savings plan. If your student chooses a less expensive school or decides not to go to college, 529 funds won’t be penalized or go to waste.

Rolling 529 funds into a Roth IRA may also kickstart good financial habits, which include regularly contributing to retirement savings, managing monthly spending and staying on top of credit reports and scores. Establishing and funding a Roth IRA early in life can set the stage for long-term retirement savings, a lifelong habit you can never start too soon.