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529-to-Roth Conversion

New regulations allow converting 529 funds into a Roth IRA

The Secure 2.0 Act, passed at the end of 2022, contained several provisions to increase participation in retirement savings accounts. They include automatic enrollments, increased tax credits for starting up a new pension plan for new/small companies, higher catch-up limits, and many other positives. Read a full summary here. The timing of these changes range from immediate to several years out.

One new provision that goes into effect next year allows funds in a 529 Plan to be rolled into a Roth IRA in the beneficiary’s name. This means if a student does not use all their 529 Plan assets (scholarship, military, overfunded, etc.), they can be transferred to a Roth IRA tax and penalty free. Currently, unused 529 assets would incur taxes and penalties when withdrawn for non-qualified purposes.

529 Plans are a great option to pay for education. The assets grow tax-free and payments for qualified education expenses are tax-free. Account owners may receive state tax benefits when contributing to a 529 Plan, depending on the plan sponsor.

For those thinking about generational wealth and transferring assets to the next and second generations, a 529-to-Roth conversion presents a new option. It is not a means to transfer great sums to younger generations since there are limitations. However, it is an opportunity to fund a descendant’s future, with some optionality. Assets cannot be spent frivolously since the funds can only be used for either educational needs, or put into a Roth IRA where the standard withdrawal taxes and penalties apply until age 59½.

The 529 Plan must be in the same beneficiary’s name for 15 years, so starting shortly after a child is born makes sense. There is also a $35,000 conversion limit per beneficiary, so it is not a means to transfer millions (although it provides for long-term compounding). Funds converted from a 529 Plan to a Roth are also subject to annual Roth contribution limits, which is currently $6,500 for individuals under age 50 with less than $138,000 modified adjusted gross income.

The final rules are still being written, so it makes sense to consult with a financial and/or tax advisor. Some things to consider though, are the state tax benefits for the account owner, gift tax limits (both annual and lifetime), beneficiary’s needs, account owner's goals and needs, contribution limits, and how colleges view assets in a 529 Plan for federal aid purposes, to name a few.

Bottom line, this new regulation provides a new option to help students by not worrying about over funding a 529 and being able to use leftover funs to create retirement savings early on.



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