One thing’s for sure—college isn’t getting any cheaper. If you’re looking to help your child cover future education costs like tuition, room and board, and more, a 529 plan offers a tax-efficient way to save.

But predicting exactly how much you’ll need is tricky. Scholarships, grants, and shifting legislation can all impact college expenses—especially if your child won’t need the funds for another decade or more. Because of this uncertainty, many parents hesitate to fully fund a 529 plan.

Now, a new rule change is easing those concerns. The recently passed 529-to-Roth IRA rollover provision allows a portion of unused 529 funds to be converted into tax-free retirement savings—offering parents even more flexibility and peace of mind when saving for the future.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings account designed to help cover qualified education expenses for a designated beneficiary, such as a child or grandchild.

One of the key benefits of a 529 plan is that any earnings grow tax-free, and withdrawals aren’t subject to federal income tax—as long as they’re used for qualifying education costs as defined by the IRS. In most cases, state income taxes won’t apply either.

Qualified expenses typically include:

• College tuition and fees
• Room and board
• Books, supplies, and other school-related expenses

Additionally, you can use up to $10,000 from a 529 plan to pay for tuition at private elementary or secondary schools.

While there are no federally mandated contribution limits, most states impose lifetime contribution caps, usually ranging from $300,000 to $500,000. Keep in mind that contributions exceeding the annual gift tax exclusion must be reported on your tax return and will count toward your lifetime gift tax exemption.

The SECURE 2.0 Act: Key Changes for 529 Plans

In December 2022, Congress passed the SECURE 2.0 Act, introducing several significant updates to retirement planning and savings. One notable provision directly addresses a common concern among parents—what happens if they overfund their child’s 529 plan?

Under the new law, if all eligibility requirements are met, 529 account holders can roll over up to $35,000 into a Roth IRA for the beneficiary. This creates an opportunity to kickstart a child’s or grandchild’s retirement savings with potentially tax-free income. Alternatively, if parents name themselves as beneficiaries, they could use the funds to boost their own retirement savings.

A Quick Refresher on Roth Accounts

Before diving deeper into 529-to-Roth rollovers, let’s take a moment to revisit what makes Roth accounts unique and beneficial for retirement planning.

Traditional retirement accounts—such as 401(k)s and 403(b)s—are funded with pre-tax dollars, reducing taxable income for the year in which they are deposited. The investments grow tax-deferred, but withdrawals in retirement are subject to ordinary income tax.

In contrast, Roth accounts are funded with after-tax dollars. While contributions don’t provide an immediate tax break, the major advantage is that qualified distributions in retirement are tax-free (including what you contributed and any growth that occurred within the account over time). 

How to Transfer a 529 Plan to a Roth IRA

Not every 529 plan is eligible for a Roth IRA rollover, as there are limitations and eligibility requirements to consider. Let’s walk through a few distinct features of this transfer option:

5-Year and 15-Year Timeline: To qualify for a rollover, there are two timelines to be aware of. First, the dollar amount you’d like to roll into a Roth IRA needs to have been in the account for at least five years. And second, the account needs to have been open for at least 15 years. This makes early planning essential—another reason parents may want to start funding a 529 plan when their child is still young.

Beneficiary: Both the Roth IRA and the 529 account will need the same person listed as beneficiary for the transfer to work. In addition, the person listed as the beneficiary will have to have earned income for the tax year they plan on completing the transfer. 

Contribution Limits: You can transfer up to the amount of earned income you have for the year or the Roth IRA contribution limit (whichever is lower). For example, if you only earned $5,000 during this tax year, that’s the maximum amount you can transfer to the Roth IRA. If you made other contributions to a traditional or Roth IRA, you need to take those into account as well. 

Lifetime Limit: There is a lifetime cap of $35,000 per beneficiary for 529-to-Roth IRA rollovers. However, it is possible to transfer funds to different beneficiaries if needed. Keep in mind, though, that making changes to the account—such as switching beneficiaries—could reset the 15-year account age requirement, potentially delaying future rollovers.

What If You Still Have Leftover Funds in a 529 Plan?

What happens if you can’t roll over your 529 plan funds into a Roth IRA? Maybe the account isn’t old enough, the beneficiary doesn’t have earned income, or you’ve already hit the lifetime transfer limit. Fortunately, you still have options.

One of the biggest advantages of a 529 plan is beneficiary flexibility. If the original beneficiary doesn’t need the funds—perhaps they received a full-ride scholarship—you can change the beneficiary to another qualifying family member at any time. This could be a younger sibling, a niece or nephew, yourself (if you’re considering further education), or even a future grandchild. There’s no deadline, so you can keep the account open indefinitely until you find the right use for the funds.

If you’d prefer to withdraw the money for other purposes, you can do so, but there’s a catch. You may have to pay a 10% tax penalty on any capital gains earned in the account (on top of the expected capital gains tax liability). While not ideal, this 10% tax penalty isn’t terrible as it essentially brings the combined rate you would pay (LTCG + 10% penalty) up to the ordinary income rate that some pay on earned income. 

Need Help Optimizing Your Savings Goals?

We know that the 529-to-Roth IRA rollover is a relatively new option, and understanding the rules can be tricky. That’s why we created an easy-to-read flowchart to help you determine whether your 529 funds may be eligible for a transfer.

Still have questions about your savings goals? We’re here to help! Schedule a time with our team to discuss your options and make the most of your education and retirement savings.

Sources:

1. https://www.irs.gov/newsroom/529-plans-questions-and-answers
2. https://www.fidelity.com/learning-center/personal-finance/529-rollover-to-roth

Lake Road Advisors, a Fee-Only, independent financial planning firm with offices in Corning, NY, Ithaca, NY and Vancouver, WA works with clients virtually all across the country. Paul Sydlansky, the founder of Lake Road Advisors LLC, has worked in the financial services industry for 20+ years. Prior to founding Lake Road Advisors, Paul worked at Morgan Stanley in Manhattan for 13 years. While at Morgan Stanley, Paul was a senior-level manager within the Institutional Equities Department. In 2018 he was named to Investopedia’s Top 100 Financial Advisors list. Paul received a Bachelor’s degree in Economics from Marist College and holds an MBA from New York University Leonard N. Stern School of Business. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network. They can be reached by phone at the Corning, NY office at (607) 438-2914, Ithaca, NY office at (607) 463-8400, or Vancouver, WA office at (607) 292-2172 or at the firm’s website at https://lakeroadadvisors.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.