Beginning in 2024, excess funds held in a 529 college savings plan will be eligible to be rolled over to a Roth IRA.
For families who funded 529 college savings plans for their children and did not fully exhaust the accounts while utilizing the funds for qualified education expenses, there is a new alternative for the remaining funds. Prior to the coming rule change, if withdrawals are made from the 529 plan that are not used for qualified education expenses, taxpayers are assessed income taxes plus a 10% penalty on the earnings portion of the distribution from the plan. However, beginning in 2024 taxpayers will be allowed to “take a tax-free distribution in the form of a Roth Conversion” made via a trustee-to-trustee transfer for the portion of the invested funds remaining in the 529 plan.
This new law change comes with a few requirements that taxpayers need to be aware of:
- There is a $35,000 lifetime cap on the total amount of transfers.
- The beneficiary’s 529 plan must have been open for at least 15 years. (With regard to the qualifying 15-year period, it is not yet clear how the 15-year period will be determined when 529 plan funds have been rolled over from one beneficiary to another beneficiary. Will the 15-year period begin with the original beneficiary or re-set with the second beneficiary who was the recipient of the transferred 529 plan funds?)
- 529 plan contributions (and associated earnings) made in the prior five years are not eligible to be rolled over.
- Each year the maximum allowed transfer from the 529 plan to a Roth IRA is capped at the annual Roth IRA contribution limit and subject to Roth contribution rules (such as meeting the earned income requirement and the phase-out for higher income earners).
- The transfer must be to the beneficiary’s Roth IRA and not to the parent’s Roth IRA.
With proper planning and a familiarity with these qualifying rules, this new taxpayer friendly rule will allow the accumulated earnings on unused 529 plans to continue to grow tax free for your child or other beneficiary over his or her lifetime.