529 Plan Rollover To A Roth IRA

Rae Hartley BeckDeputy Editor of Investing and Retirement

Rae Hartley Beck first started writing about personal finance in 2011 with a regular column in her college newspaper as a staff writer. Since then she has become a leader in the Financial Independence, Retire Early (FIRE) movement and has over 100 bylines in prominent publications including Money, Bankrate and Investopedia on all things personal finance. A former award-winning claims specialist with the Social Security Administration, Rae continues to share her expert insider knowledge with Forbes Advisor readers.

Rae Hartley Beck

Rae Hartley BeckDeputy Editor of Investing and Retirement

Deputy Editor of Investing and Retirement

Benjamin Curryeditor

Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree.

Reviewed

Benjamin Curry

Benjamin Curryeditor

editor

Reviewed

Updated: Apr 12, 2023, 8:38pm

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.

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Making the right investments to help pay for the college education of a child or grandchild presents something of a conundrum. The 529 plan offers tax benefits for college savings, but this useful tool has been underutilized for years.

College isn’t necessarily the ticket to success it once was. But with tuition costs increasing 180% from 1980 to 2020, not saving for college guarantees your loved one could end up saddled with student debt, especially since median wages have only increased by 50.4% over the same time period.

But saving too much for college can be risky as well. Nearly one-third of college students drop out before finishing their degree, according to the education data initiative. A survey conducted by the nonprofit group Educational Credit Management Corporation (ECMC) found that only 51% of current high school students plan on pursuing a four-year degree.

Thankfully, Secure Act 2.0 made important changes to 529 plans that might just help boost their popularity and resolve some of these investor dilemmas.

What Is a 529 Plan?

A 529 plan is a tax-advantaged investment account designed to help families save money for a child’s education.

This type of investment account offers valuable tax benefits, and almost anyone—parents, grandparents or friends—may open a 529 plan and contribute money to the account. You can even open and contribute to a 529 plan for yourself.

To open a 529, you must be a U.S. citizen or resident alien. You must have a Social Security or tax identification number. And you must have a permanent U.S. address that is not a post office box.

Contributions made to a 529 plan are money on which you’ve already paid taxes, and investments in the account grow tax deferred. You can qualify for state income tax deductions in 35 states and the District of Columbia, and contributions are not subject to annual gift tax limits.

Each 529 plan has an account owner, who makes contributions and selects investments, and a named beneficiary whose education expenses may be paid from the account. Money in an account is typically invested in diversified mutual funds.

The funds held in a 529 plan—contributions and tax-deferred investment gains—may be used to pay for qualified educational expenses for the named beneficiary. These include things like college tuition, books and educational supplies, room and board, and student loans. You can also pay for up to $10,000 a year in K-12 educational costs.

Limitations of the 529 Plan

In the past, the tricky part of managing a 529 plan was how to use the money if the beneficiary decided not to go to college.

Money in a 529 plan account may only be spent on the qualified expenses outlined above, and withdrawals for any other purpose are subject to a 10% IRS penalty. Experts suggest 529 plans were underutilized due to these concerns.

“Any perceived inflexibility with any financial product can limit participation,” says Chris Lynch, President of TIAA Tuition Financing. “A common concern we often hear from potential 529 plan purchasers is regarding the lack of rollover flexibility. People want to know they will not be penalized if their children do not attend higher education.”

According to Patricia Roberts, the chief operating officer of Gift of College, there are ways around these perceived limitations.

“These plans can be used for many different forms of education than just college, and the original beneficiary can be changed at any time to other members of their family, and even the future children of the existing beneficiary,” says Roberts.

Secure Act 2.0 Changed the Rules for 529 Plans

The Secure Act 2.0 introduced a raft of reforms to the laws governing retirement in the U.S., as well as the rules for 529 plans. That’s good news that could make it easier for participants to get more value out of 529s.

Secure Act 2.0 directly addressed concerns that money might be wasted if a beneficiary didn’t go to college by permitting Roth IRA conversions for 529 plans. Starting in 2024, the new provision allows up to a lifetime total of $35,000 to be rolled over from a 529 plan to a Roth IRA established in the name of the beneficiary.

Thanks to this change, even if a child doesn’t end up going to college or otherwise making use of the money saved in a 529 plan, you’ve still helped safeguard their financial future and stability by contributing to a 529 plan on their behalf.

Beneficiaries of 529 accounts that have been open for more than 15 years can roll over up to $35,000 over time into a Roth IRA in their own name.

What Is a 529 Plan Rollover?

Rolling over funds from a 529 plan to a Roth IRA are subject to the earned income requirements, annual contribution limits and income limits.

In 2023, you may contribute an annual maximum of $6,500 to a Roth IRA. You or your spouse must have at least $6,500 in earned income and under $138,000 in adjusted gross income for a single filer or under $218,000 for married people filing a joint return.

Income limits and contribution limits will change over time, but under the current rules it would take you just over five years to roll over the full $35,000 lifetime limit.

If you were a beneficiary of a 529 plan and decided not to attend college, and you started rolling the money into a Roth IRA when you were 18, you would have $35,000 in your account by the time you turned 24.

Let’s say you invested it in something like the Fidelity 500 Index Fund (FXAIX), one of our top picks for the best S&P 500 index funds. If your money continued to grow at the 10.40% average annual rate of return since the fund was started in 1988, you’d have $2,486,771.85 in tax-free savings at age 65 for retirement without ever having contributed an additional penny to your account.

How to Build Generational Wealth with a 529 Plan

If you are looking to build generational wealth, you’d be hard-pressed to find a better option than a 529 plan. Not only do you get tax-free investment growth, but the plan beneficiary may be changed at any time.

Thanks to the new $35,000 Roth IRA rollover provision, a 529 plan is among the most useful tools for guaranteeing long-term economic security for your loved ones. That’s because Roth IRA contributions can be withdrawn at any time.

That $35,000 you converted to a Roth IRA? It could be a $35,000 emergency fund that can be used to cope with difficult circumstances. Left untouched, the money could grow into millions over the years, long after you’re gone.

If you’d like to use a 529 plan to create a legacy, you’ll want to open one soon. The account needs to be open for 15 years before a Roth IRA conversion can happen. You can open the account in your own name and change the beneficiary name at a later date.

Use our investing calculator to see the amount you’d need to contribute to have $35,000 in the account in 15 years or more. If you’d also like to save enough for college, you can use a tool like Vanguard’s college savings planner to determine how much you’d need to cover a specific college.

If you want to cover both estimated college costs and leave enough to rollover to a Roth IRA, be sure to add both numbers together to determine how much to contribute.

Remember, even if they don’t go to college or use the amount, the beneficiary can be changed to another friend or relative. You could even use the funds to start a scholarship for a child who otherwise wouldn’t be able to afford school. Be aware that changing the beneficiary to a non-relative of the current beneficiary can have tax implications.

Should You Choose a 529 Plan with No State Tax Deduction?

Remember, there are 35 U.S. states that offer a state income tax deduction for money contributed to a 529 plan. But even if your state doesn’t offer a tax deduction or offers a very limited one, you should still consider socking money away in a 529 plan if you can afford to without sacrificing your own economic security.

“Even if your state does not offer an annual deduction or credit, the tax-free growth and tax-free withdrawals available with 529 plans make them worth considering from a tax perspective.” says Roberts.

The combination of beneficiary flexibility, tax-free growth and eventual Roth IRA conversion makes a 529 plan a powerful financial planning tool even before considering a state tax deduction.

Let’s say you invested $35,000 the day a child is born using the FXIAX index fund and historical returns we noted above. By the time your child turned 18, it would have grown to be worth $135,000 in a taxable account like a UTMA, or $207,736 in a 529 plan. That’s a difference of $72,736.