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529 college savings plans are powerful tools to help pay for the rising costs of education. However, some are hesitant to use them.
A common concern is oversaving. You can only use 529 funds and can only cover qualified education expenses without incurring a tax penalty, but it can be difficult to determine how much money you actually need.
Many parents open 529s for their children at birth, when there is no way of knowing if their children will get a scholarship or go to college. Fortunately, parents of multiple children can change the beneficiary of a 529 plan.
But what if you still have money left after paying for your studies?
Thanks to Act safely 2.0you can now transfer unused 529 fund to a Roth IRA. But the 529 rollover is not a loophole to save more for retirement; the rules limit conversions.
Here’s what you need to 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 have been open for at least 15 years.
You cannot convert 529 contributions made in the last five years (or the income from those contributions).
The 529 funds you transfer count toward your annual IRA contribution limit.
You can transfer a maximum of $35,000 from a 529 plan to a Roth IRA over your lifetime.
529 funds must be converted by paying the amount directly to a Roth IRA. You can’t pay for it yourself and then deposit the money into the Roth IRA later.
You can only contribute to a Roth IRA if you receive income from a job. The 529 beneficiary must therefore have qualifying income when 529 to IRA conversions occur.
Roth IRA income limits do not apply to 529 rollovers.
While avoiding the Roth IRA Income limits are a retirement savings benefit for those with higher incomes, the remaining rules regarding rolling over excess 529 funds are designed to ensure that people use 529 plans for education as intended. Annual contribution limits and the lifetime cap on conversions mean you can’t double your pension pot.
So what is the end result?
The ability to convert unused 529 funds into a Roth IRA can ease potential fears of oversaving for education. Still, don’t rely on your 529 as a way to save for retirement. Instead, consider funding your Roth IRA separately.
529 transfers to ABLE accounts
Families with a disabled child can transfer their 529 account to an ABLE account, a tax-advantaged way to save for the needs of a disabled person while maintaining eligibility for government assistance. It uses the same legal framework as the 529 plan and functions similarly. Contributions are made in after-tax dollars to a plan with a defined menu of investment choices. Earnings compound tax-free, and withdrawals to pay for qualified expenses are also tax-free.
