You may have heard that you can use 529 Plan money to fund a Roth IRA. But how does it work? And why would you want to do this?
College savings (529) plans are popular tools for saving for college. But the big concern is always: what if my child doesn’t go to college? Will I end up paying penalties if I withdrawal the funds for another purpose? The Secure Act 2.0 made college savings accounts more flexible and helped reduce this risk beginning in 2024. Now, if you have money left in a 529 plan for any reason, you may be able to use it to fund a Roth IRA for the 529 plan beneficiary.
How does using a 529 plan to fund a Roth IRA work?
You need to meet a few requirements:
- The account must have been open for at least 15 years.
- The dollar amount you’re planning to transfer to the Roth must have been in the account for at least 5 years.
- The beneficiary of the 529 plan must be the same as the Roth IRA owner
- The Roth IRA owner must have earned income equal to or greater than the amount being transferred from the 529 to the Roth
- The annual Roth contribution limits still apply ($7,000 total for 2024), and the funds transferred from the 529 count toward the limit
- You can’t exceed a $35,000 lifetime limit for these transfers for each 529 beneficiary
What Are the Considerations with Funding a Roth IRA from a 529?
The biggest reason to pursue this strategy is if there are funds remaining in a 529 plan that aren’t going to be used for educational purposes. Transferring it to the Roth instead of making a withdrawal that’s not for educational expenses avoids the 10% penalty and federal income tax on the earnings.
If college expenses are still pending and you have other funds to make Roth IRA contributions, it’s probably best to allow the funds in the 529 plan to keep growing tax-free and to make the Roth IRA contribution with separate funds. Because any transfers from the 529 to the Roth count toward your annual IRA contribution limit, you’re not actually getting any more money into the Roth IRA than you otherwise would.
Another long-term strategy to consider — if a family has the funds available to put more into a 529 plan than is needed for college when a child is young, the tax-free growth period of assets that will eventually be used to fund a Roth IRA can start with the initial 529 contribution.
There are still some unknowns
Because 2024 is the first year the 529 to Roth IRA transfer is available, we’re still awaiting more specific IRS guidance. As such, it likely makes sense to wait until later in the year to attempt these transfers so there’s more clarity. For example, we don’t know if changing the beneficiary of the 529 plan resets the 15-year clock. We also don’t know if there will state income tax consequences to these transfers. Here’s a link to the My529 plan guidance on the topic.
If you’d like to discuss how this affects your situation, please let us know.