529 to Roth IRA Transfers

With the passage of Secure 2.0, many people are revisiting the 529 plan and its role in their financial plans.

The most common objection to 529 plans is usually around the lack of flexibility. The concern is not all funds will be needed for college, and this money will be “stuck” in the 529 unless a penalty is paid to access it.

While there are ways to minimize or eliminate the penalty if 529 funds exceed qualified expenses, we’ll focus on the additional flexibility of 529s due to Secure 2.0.

Beginning in 2024, 529 funds will be able to be transferred to Roth IRAs. While this is certainly good news, some limitations make it less of a slam dunk than it seems at first glance.

Limitations on 529 to Roth Transfers

“Conversions” are limited to the year’s IRA contribution limit.

The quotation marks are there because this is very different from how we think about Roth conversions. This isn’t like going from a Traditional IRA to Roth IRA, when we can choose how much to convert each year. For 529s, transfers will be capped at the contribution limit for the year.

On a positive note, Roth IRA earning limits will not apply. The children of high earners are often high earners themselves, so this is welcome news.

Beneficiaries must have compensation.

These transfers can boost retirement savings for beneficiaries who are working. They are not an option for years they don’t have compensation.

The Roth IRA must belong to the beneficiary.

This makes sense, but it raises some questions we don’t have answers to at this time due to the next requirement.

The 529 must be open for 15 years.

Does changing the beneficiary reset the clock? We don’t know yet. We’ll have to wait for guidance from the IRS.

This means many of us should open and fund 529s for children now. Put in a dollar to get the clock running. We can fine-tune the 529 funding strategy later.

The previous five years plus earnings cannot be transferred.

This is where it will take some finesse to benefit. When making the transfer, you must exclude the previous five years of contributions and the earnings on these contributions.

This creates a moving window we must work around. Over time, more would be available to transfer as the five-year window moves. Like most planning-related matters, this strategy will likely take years to execute.

There’s a lifetime maximum of $35,000 per beneficiary.

This provides a cushion in case we overfund the 529 relative to qualifying expenses, but we must still be reasonable in calculating college costs.

Are 529 to Roth IRA transfers worth it?

For many people, this option will help reduce the risk of over-contributing to 529 plans and should increase 529 contributions. This is positive, as the tax savings and behavioral benefit of having funds set aside make us intentional with funding the significant expense of education.

These limitations will prevent these transfers from becoming a major wealth transfer tool, however. We can take advantage of the additional flexibility this tactic offers, but we shouldn’t make extensive changes to our plans because of it.

Need help with your education or wealth transfer planning? Contact us.