Would you like to fund a 529 plan for your child or grandchild and don't want them to incur penalties when withdrawing the unused funds? If so, this article explains what you need to know about transferring unused funds from a 529 plan to a Roth IRA.
A Brief Meaning of a 529 Plan and Roth IRA
A 529 plan, also called a qualified tuition plan, is a tax-advantaged education savings plan approved by Section 529 of the Internal Revenue Code. It was created to promote saving for future education costs.
Before the introduction of the SECURE Act 2.0, you needed to make a nonqualified withdrawal if you wanted to use the funds for nonqualified education costs. To discourage these withdrawals, 529 plan account owners had to pay a 10% federal tax penalty.
A Roth IRA is a retirement account funded with after-tax money, usually a post-tax salary. The account grows tax-free, and your withdrawals are also tax-free, provided they adhere to certain conditions.
Can You Convert a 529 Plan to a Roth IRA?
Yes. This is made possible by the SECURE Act 2.0, signed into law on December 29, 2022. You can transfer unused dollars in your 529 plan to a Roth IRA without incurring any taxes as of January 1, 2024.
A 529 account owner or beneficiary can transfer up to $35,000 to a Roth IRA during their lifetime without paying taxes or penalties. You need to comply with certain conditions for this transfer to occur:
You must be the owner of both the 529 plan and the Roth IRA.
The annual transfer amount must not exceed the prevailing Roth IRA’s yearly contribution limit. For example, you’re allowed to transfer a maximum of $7,000 if you’re younger than 50 years old or $8,000 if you’re 50 or older in 2024.
Your 529 plan must have existed for at least 15 years before you made the conversion.
You are not allowed to transfer any funds that went into your 529 plan in the last five years.
Note that these rules may change going forward as the Internal Revenue Service figures out how to get all people to comply with this rule.
Some states don’t recognize 529 plan transfers to Roth IRAs as qualified. You may, therefore, incur state income tax or be liable for tax benefit “clawbacks"—recovery of tax incentives previously granted to you.
Before you start the rollover process, make sure that you have set up a Roth IRA.
Contact your 529 plan provider and complete all the necessary forms for the transfer request. Withdraw the qualifying funds from your 529 plan and deposit them into your Roth IRA within 60 days.
Remember that you must own both the 529 plan and Roth IRA for the rollover to go off successfully.
Conclusion
If you are a parent, grandparent, or guardian, you can rest assured that you can fund a 529 plan for your child and move the unused money to a Roth IRA tax-free.
Of course, the account owner or beneficiary must be eligible for this transfer to enjoy the tax-free benefit.
If you need help with financial planning, contact JDH Wealth.