If you’ve invested in a 529 plan to save for a child’s or grandchild’s education, you may be wondering what happens to the funds if they aren’t all used for that purpose. Fortunately, the SECURE 2.0 Act, effective in 2024, introduces a new option: you can now roll over unused 529 plan funds into a beneficiary’s Roth IRA, up to a certain amount, without paying taxes or penalties. While the IRS is still expected to provide more guidance, this presents a valuable opportunity that is worth discussing with your wealth advisor and tax professional.

What to Do with Unused 529 Plan Funds

Before the SECURE 2.0 Act, the options for unused 529 funds were somewhat limited. You could save them for further educational expenses, transfer the funds to another family member’s 529 plan, or make a nonqualified withdrawal, which would be subject to both taxes and penalties. Now, however, beneficiaries can roll over leftover education savings into a Roth IRA, helping to kickstart retirement savings.

How the Rollover Works

Starting in 2024, you can roll over up to $35,000 from a 529 plan into a Roth IRA for a beneficiary, but there are some restrictions. The rollover must be done gradually, with the annual limit matching the IRA contribution limit, which is $7,000 in 2024 for individuals under age 50. The rollover must also be made to a Roth IRA in the name of the 529 plan beneficiary.

Roth IRAs offer significant tax advantages: the funds grow tax-deferred, and as long as certain conditions are met, withdrawals are both tax-free and penalty-free.

Important Considerations

To be eligible for the rollover, the beneficiary must have earned income from work. The maximum rollover for a given year is the lesser of the beneficiary’s earned income or the IRA contribution limit. High earners, who are typically ineligible to make direct Roth IRA contributions due to income limits, are not subject to these restrictions when rolling over funds from a 529 plan.

There are also other important conditions to be aware of:

• The 529 plan must have been open for at least 15 years.
• Contributions made within the last five years and the earnings on those contributions are not eligible for rollover.
• The rollover must be a direct transfer from the 529 plan to the Roth IRA (not through the individual’s hands), meaning it must be processed as a trustee-to-trustee transfer.

IRA Contribution Limits and Timing

It’s important to note that any Roth IRA contributions, including rollovers, count toward the annual contribution limit. For instance, if the beneficiary has already contributed $3,000 to their Roth IRA in 2024, they could only roll over an additional $4,000 from the 529 account that year. This annual cap means that it may take several years to reach the $35,000 lifetime rollover limit.

State Tax Considerations

One aspect that remains unclear is how different states will treat these rollovers for state income tax purposes. While the federal government allows 529-to-Roth IRA rollovers without penalties, some states may not follow this approach. Certain states may need to update their laws to treat these rollovers as qualified expenses for tax purposes, while others may not make any changes. It’s essential to understand your state’s tax rules before proceeding with this strategy.

The Benefits of the New Rollover Rule

With the cost of education rising, it’s smart to fully fund a 529 plan for your child or grandchild. And now, thanks to the new Roth IRA rollover option, any unused funds in the 529 plan can still serve a valuable purpose—helping the beneficiary build retirement savings. This new rule provides more flexibility and peace of mind for those saving for education, knowing that leftover funds won’t go to waste.