Article
What do you do with excess funds in a 529 Plan?
Imagine that if, as a parent, you have saved diligently to fund your child’s 529 plan so that she can attend the college of her dreams, but instead your daughter chose to enroll at a public university rather than a private one. You have money left over in the 529. Good news! You can take advantage of a new option for utilizing the remaining funds in the 529 plan and build a nest egg for your daughter.
Recent legislation (part of the SECURE 2.0 Act) has created a new way to use 529 plan funds to fund retirement savings. Starting January 1, 2024, beneficiaries of 529 plans can roll over up to a lifetime limit of $35,000 into a Roth IRA—free of tax and penalties. This new tool is a great way to supercharge a Roth IRA for an individual who does not need the funds for college. If you start rolling over funds from the 529 plan at your child’s age 21, the funds could grow to over $1,000,000 by the time the child retires at age 70!
Because of this new legislation, parents (or grandparents) may choose to overfund a beneficiary’s 529 plan in order to take advantage of this new rule and begin a retirement fund for their children/grandchildren. As you contemplate rolling money from a 529 plan to a Roth IRA, you want to ensure you follow the following rules:
- The beneficiary of the 529 plan must be the same individual as the owner of the Roth IRA.
- The 529 plan must have been in existence for 15 years.
- No contributions or earnings from the previous 5 years can be transferred from the 529 plan into the Roth IRA.
- The transfers are limited to the annual Roth IRA contribution limit for that year less any “regular” traditional or Roth IRA contributions that have been made in that year. For example, if the annual contribution limit is $6,500, and you have already made a $1,000 contribution to the Roth IRA, you are only allowed to roll over $5,500 from the 529 plan to the Roth IRA. The IRS sets the contribution limit, which changes annually.
- The individual must have earned income to make the transfer. The transfer cannot be for more than the compensation received or for more than the annual Roth IRA contribution limit.
- There are no annual income limits for the transfer, unlike a regular Roth IRA contribution that has a modified adjusted gross income limit.
- The rollover is made directly from the 529 plan to the Roth IRA. (Remember – you are only able to have one rollover for a 529 plan in one year. This transfer counts as that rollover.)
The funds will grow tax-free in the Roth IRA. If the Roth IRA owner leaves the funds in the Roth until age 59 1/2, any withdrawals will be tax-free. Using money from a 529 plan to fund a Roth IRA allows a parent to provide a nest egg to their child to help ensure their child’s financial stability in retirement.
You should seek the advice of a financial advisor or CPA when considering a 529 plan conversion to a Roth IRA.
