One feature of Secure Act 2.0, which was signed into law in late 2022, is a provision allowing for tax-free rollovers from Section 529 college savings accounts to Roth IRAs. Starting in 2024, 529 plan account owners or beneficiaries can roll over 529 funds into a beneficiary-owned Roth IRA tax-free and penalty-free, subject to certain limitations. This also counts toward 2023 Roth contributions made in 2024.
However, the IRS has yet to provide detailed guidance on the rules that will apply to these rollovers.
529-to-Roth Rollover: Basic Rules
- Provides relief from the rule that nonqualified distributions are subject to tax on earnings and penalty.
- The rollover is reported like any other Roth IRA contribution on IRS Form 5498.
- A rollover can only be made to the Roth IRA of the 529 beneficiary and not the owner of the 529 account. In addition, the beneficiary must have earned income.
- When former 529 contributions are ultimately distributed from the Roth IRA, any funds rolled over will be treated as if they were rolled over from another Roth IRA. Contributions come out tax- and penalty-free, and earnings come out tax- and penalty-free if the distribution is qualified.
- The 529 account must have been “maintained” for a minimum of 15 years before rolling funds to a Roth IRA.
- 529 contributions and earnings made in the last five years cannot be rolled over.
- The maximum lifetime amount that can be rolled over is $35,000 per beneficiary.
- The maximum annual rollover is limited to the amount that can be contributed to an IRA in that year. For example, the 2024 IRA contribution limit is $7,000 ($8,000 if the beneficiary is over age 50).
- In addition, the annual amount eligible for rollover is reduced by any traditional or Roth IRA contributions made for that tax year. In other words, the 529 rollover replaces the taxpayer’s IRA contribution for the year. This means that rollovers of excess 529 plan funds will likely need to be accomplished over a period of several years.
Open Issues
As the new rule is live, there are many investors and advisors now looking to move 529 money to a Roth IRA. However, there are still several unanswered questions that will require further guidance from the IRS before greater adoption of 529 rollovers can occur. Among the outstanding open questions are the following:
- Does the $35,000 limit apply on a per-beneficiary basis or apply to each taxpayer who funded the account? For example, the IRS has not provided guidance on whether a parent who funds 529 plans for two children would be entitled to roll over a maximum of $35,000 or $70,000 ($35,000 per beneficiary).
- Does moving from one 529 program to another reset the 15-year or 5-year period?
- Taxpayers who fund a 529 plan are allowed to change the account beneficiary. However, the IRS has not clarified how the 15-year period is calculated when the taxpayer does change beneficiaries. Will a new 15-year waiting period be required starting from the date the beneficiary is changed, or will it begin with the date the account was opened?
- It’s not yet clear if all states will treat these rollovers as a qualified expense for state income tax purposes. Not all states follow the federal definition of qualified expenses for 529 plans, and in states that don’t, there could be state tax penalties caused by a 529 to Roth IRA rollover. Some states will need to update their laws to include these rollovers as a qualified expense; others may choose not to do so.
- What reporting is going to be required from the 529 program manager to the Roth IRA custodian? And will the custodian need to track basis?
What to Look for Next
The ability to convert 529 plan funds to a Roth IRA removes one of the biggest drawbacks of investing in 529 plans: the fear of incurring penalties if the funds are never used for qualified education expenses.
These new rules increase 529 plan flexibility, giving people another reason to save for college without worrying about someone not attending college.
While there are still some unanswered questions and the industry awaits further guidance, most 529 plans have begun processing rollover requests.
As for the next steps, the College Savings Foundation filed a letter with the IRS seeking guidance and the IRS has said that it has placed it on its Priority Guidance Plan.
The bottom line is that if someone is planning a 529-to-Roth IRA conversion in 2024, it might be best to wait until later in the year as the IRS and states may issue more guidance in the meantime.
SS&C is the leader in 529 plan administration and recordkeeping technology for the biggest program managers in the country. We will continue to provide updates on any changes to the rules and IRS guidance as soon as they become available.
