Maximizing Unused 529 Plan Funds: The 529-to-Roth IRA Transfer Option
Posted by Bradley Bach on February 27, 2024
With the escalating costs of higher education, many parents wisely start saving early by contributing to 529 college savings plans for their children. While these plans don’t offer tax deductions on contributions, they do provide tax-deferred growth. Qualified education expenses can be withdrawn from these accounts tax-free. However, using earnings for non-educational purposes may trigger income tax and a 10% penalty.
But what if you find yourself with a substantial balance in a 529 plan, and your child doesn’t require all the funds for college? Perhaps your child opted not to attend college or received a scholarship. Alternatively, you may have saved for private college, but your child ended up attending a more affordable state university.
Exploring Your Options
When faced with unused 529 funds, there’s more than one path to consider. While paying taxes and penalties and using the money as you see fit is an option, there’s a tax-efficient alternative: the 529-to-Roth IRA transfer.
The Basics
Starting in 2024, you have the opportunity to transfer unused funds from a 529 plan directly into a Roth IRA designated for the same beneficiary—without incurring taxes or penalties. Here are the key details:
- Lifetime Maximum: Each beneficiary can make transfers up to a lifetime maximum of $35,000.
- Plan Duration: The 529 plan must have been in existence for at least 15 years.
- Direct Transfer: The rollover must occur through a direct trustee-to-trustee transfer.
- Exclusions: Transferred funds cannot include contributions made within the preceding five years or earnings on those contributions.
- Annual Limits: The transfer is subject to the annual contribution limits for Roth IRAs, regardless of income thresholds.
Illustrative Example
Let’s walk through a scenario: Suppose you opened a 529 plan for your son when he was born in 2001. By the time he graduated from college in 2023, there remained $30,000 in the account. Now, in 2024, you can initiate the transfer to your son’s Roth IRA under this new option. Since the 529 plan has been active for at least 15 years (with no contributions made in the last five years), the only limitation is the annual Roth IRA contribution limit.
By leveraging this strategy, you can optimize your unused 529 funds while ensuring tax efficiency. Remember to consult with a financial advisor to explore the best approach based on your specific circumstances.
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Bradley joined the Firm with thirteen years of experience in both public and private accounting. As a principal in the Firm's tax department, Brad's primary focus is in the construction industry and in real estate partnerships and transactions. He also provides tax planning and compliance for high-wealth individuals.