529 education savings plans are powerful tools to help pay for the rising costs of education. However, some people are hesitant to use them.
A common concern is excessive savings. You can only use 529 funds to cover qualified educational expenses without incurring a tax penalty, but it can be difficult to determine how much money you really need.
Many parents open 529 forms for their children at birth, when there is no way to know whether their children will get a scholarship or go to college. Fortunately, parents with multiple children can change the beneficiary of a 529 plan.
But what do you do if you still have money left after covering education expenses?
Thanks to the Secure Act 2.0, you can now roll over your unused 529 fund to a Roth IRA. But the 529 plan rollover isn’t a loophole to save more for retirement; Rules limit conversions.
Here’s what you should consider when converting 529 funds to a Roth IRA.
What are the rules for converting a 529 plan to a Roth IRA?
The Roth IRA receiving the funds must be in the name of the 529 plan beneficiary.
The 529 plan must be open for at least 15 years.
You cannot convert 529 contributions made in the last five years (or the earnings from those contributions).
Any 529 funds you roll over count toward your IRA’s annual contribution limit.
You can transfer a maximum of $35,000 from a 529 plan to a Roth IRA during your lifetime.
529 funds must be converted by paying the amount directly to a Roth IRA; You can’t pay yourself and then put the money into a Roth IRA.
You can contribute to a Roth IRA only if you have income from a job, so the 529 beneficiary must have eligible income when 529-to-IRA conversions occur.
Roth IRA income limits do not apply to 529 rollovers.
While avoiding Roth IRA income limits is a retirement savings advantage for those with higher incomes, the remaining rules on rolling over excess 529 funds are designed to ensure that people use 529 plans for education as intended. Annual contribution limits and a lifetime limit on conversions mean you can’t double your retirement funds.
So what is the end result?
The ability to convert unused 529 funds to a Roth IRA can alleviate potential concerns about oversaving for education. Still, don’t count on your 529 as a means to save for retirement. Instead, consider funding your Roth IRA separately.
529 rollovers into ABLE accounts
Families with a child with disabilities can transfer their 529 account to an ABLE account, a tax-advantaged way to save for the needs of a person with a disability while maintaining eligibility for government assistance. It uses the same legal framework as 529 plans and works in a similar way. Contributions are made with after-tax dollars to a plan with a set menu of investment options. Earnings are compounded tax-free and withdrawals to pay for qualified expenses are also tax-free.