[Editor's Note: We're taking a unique approach to today's post. Since Secure Act 2.0 has added the ability for investors to move 529 money into a Roth IRA, there have been plenty of questions about how this will work and whether it's worth it for a white coat investor to do it. In the first half of this post, WCI contributor explainer Eric Rosenberg explains the nuts and bolts of the 529-to-Roth-IRA transfer, and then, WCI founder Dr. Jim Dahle gives his take on whether you should actually bother with it.]
By Eric Rosenberg, WCI Contributor
For years, savvy investors have understood that funds in a 529 plan could only be used for approved education-related expenses. However, with Secure Act 2.0, 529 accounts can be rolled over into a Roth IRA. Here’s a look at how to roll over a 529 into a Roth IRA and the restrictions you should know to ensure your rollover isn’t subject to taxes and penalties.
When Can 529s Be Rolled Over to Roth IRAs?
Thanks to Secure Act 2.0, over-savers in a 529 account are no longer stuck where funds are either used for education or withdrawn with penalties. Starting in 2024, you can roll over some or all of your 529 balance to a Roth IRA. We’ll get into the limits and restrictions in just a moment.
The benefits here go beyond liberating funds from your 529. It also turns your 529 into a retirement account for long-term investors with high incomes limiting what they can invest in a Roth IRA. Many medical professionals may want to take note as they save for their children’s education and retirement.
529 to Roth IRA Rollover Limits and Restrictions
Before you go all-in on the 529, it’s critical to note the restrictions for 529 to Roth IRA rollovers. The biggest limits to understand include the following.
- Lifetime limit: There’s a $35,000 lifetime limit on 529 to Roth IRA conversions per person. While you can change the beneficiary of a 529, it’s wise to avoid investing to a point where you would exceed that limit if you intend to convert it to a Roth IRA.
- Minimum holding period: The 529 account must be assigned to the beneficiary for at least 15 years before converting. For example, you can’t change the 529 from your child’s name to your name and begin rolling over to a Roth IRA the next year.
- Annual conversions can’t exceed the annual Roth limit: While there’s no annual income limit for rolling funds from a 529 to a Roth IRA, you need to have as much earned income as you roll over, and you can’t roll over more than the annual Roth IRA contribution limit (in 2023, that limit is $6,500, and in 2024, it will increase to $7,000).
- It only works with Roth accounts: You can’t roll funds from a 529 into a traditional IRA. You’re only allowed to roll over to a Roth IRA account.
The IRS may issue more rules or clarifications in the future, but this should give you a general idea of what’s allowed.
More information here:
How to Roll Over a 529 into a Roth IRA
If you’re ready to begin your rollover, follow these general steps:
- Prepare your 529 account: First, it’s time to get your assets ready to transfer. If you’ve held the account in your name for at least 15 years, decide which assets you want to transfer or sell to move the funds in cash. Some brokerages charge fees for asset transfers (an Automated Customer Account Transfer or ACAT transfer), but you should be able to move cash for free. Find the best 529 accounts here.
- Open a Roth IRA if you don’t already have one: If you don’t already have a Roth IRA account, open a Roth IRA under the same name as the beneficiary. If you’re using the 529 to Roth IRA transfer for yourself, both accounts need to be in your name. The same goes if your child is the one who will do the rollover. Both accounts need to be in their name.
- Double-check your annual income and limits: Ensure you have at least as much earned income as you’ll be transferring and that you're transferring less than the annual limit. For 2024, the annual Roth IRA contribution limit is $7,000 if you’re under age 50 or $8,000 if you’re 50 or older.
- Transfer assets: If everything looks good, enter your asset transfer. You should be able to use a check or electronically transfer directly from the 529 to the Roth IRA.
- Confirm your transfer and plan for next year: After a few days, you should see the funds in your Roth account. It will be in cash. Make your investment choices and start planning for next year.
Using a 529 Instead of Doing Backdoor Roth IRA Contributions
If you want the tax benefits of a Roth IRA but earn too much to contribute the maximum amount (of if you have a pro-rata issue keeping you from doing the normal Backdoor Roth IRA process), you can use a 529 plan to invest for retirement. If you don’t exceed $35,000 in account value and hold the account for at least 15 years, you can put funds into a 529, knowing you’ll move them to a Roth IRA. But that assumes you will still have enough earned income later to make the contribution but not so much that you would need to do it via the Backdoor Roth IRA process.
You may end up with more than $35,000 in the account if you have outstanding investment performance. If that happens, you may want to change the account beneficiary to a spouse or child. Depending on the account size, you should be careful to avoid gift taxes when changing the beneficiary.
More information here:
Roll Over a 529 into a Roth IRA with Care
You may run into limits or restrictions, but by using a 529 account, you can plan how to boost your Roth IRA balance beyond traditional limits. If you’re a high-income family looking to save on taxes, the new 529 to Roth IRA rollover could be an extremely valuable tool.
Editorial: Is Rolling Over Your 529 to a Roth IRA a Good Idea?
By Dr. Jim Dahle, WCI Founder
Eric has done a nice job summarizing what we know about this new 529 to Roth IRA rollover option. Like the editorials often published after a study in a medical journal, I feel a need to make some commentary about the technique. I want to make several points.
Nobody Has Ever Done This
The first is that I don't know anyone who has actually done a 529 to Roth IRA rollover. I don't even know of an investment company that is facilitating it. It may be a little premature to publish a “how-to” guide to the process.
Another Relief Valve for an Overfunded 529
The second point is that I think this is best considered another relief valve for an overfunded 529. Lots of people are afraid to save for college in a 529 because they're worried they'll end up oversaving. Maybe your kid goes to a cheaper college or gets a scholarship or doesn't go to school at all or whatever. There are lots of provisions that allow you to do something productive with your 529 dollars besides paying for college. Well, now there's one more. If you need a review of all the things you can do with an overfunded 529, here's a list:
- Change the beneficiary to your grandkids (this is my plan and I think the best plan for most).
- Change the beneficiary to someone else, including you.
- Pull the principal out tax- and penalty-free.
- Pull out an amount of earnings equivalent to scholarships received penalty-free (but not tax-free).
- Pull out an amount of earnings equivalent to the cost of attendance if the beneficiary attends a military academy (again penalty-free but not tax-free).
- Pull earnings out penalty-free but not tax-free if the beneficiary dies or is disabled.
- Roll the money into an ABLE account if the beneficiary is disabled.
- Roll up to $35,000 into the beneficiary's Roth IRA in lieu of their own contributions.
- Pull the money out and just pay the taxes and 10% penalty, knowing that years of tax-protected growth at least partially made up for it.
See? Lots of options. Now, there's one more.
This Isn't That Awesome
The third point is that this is not as awesome as it sounds. You can't put $35,000 in there all at once; it has to be dribbled in over several years. The beneficiary still has to have earned income equal to the contribution each year. Depending on IRA contribution limits, it may take up to five years to get all $35,000 into the Roth IRA. The $35,000 amount isn't indexed to inflation. The money has to stay in the 529 for at least 15 years. It doesn't work if your beneficiary becomes a high earner and direct Roth IRA contributions aren't allowed. There's no Backdoor 529 to Roth IRA rollover. Even if you do this, you're just moving money from one tax-protected account to another; you're not actually increasing your tax-protected space.
Should You Deliberately Overfund?
Finally, we get to the question that has been on many of your minds ever since Secure Act 2.0 passed. Should you deliberately overfund a 529 JUST to do this later for your beneficiaries and/or yourself? When you're thinking about this, you're already at an incredibly high level of financial optimization. You know, like if you rated things on a spectrum of 1 to 10 with 1 being the ultra-satisficers and 10 being the super-optimizers, then saving for retirement is a 1 and using a tax-protected account like a Roth IRA or 401(k) is a 2. This 529 to Roth IRA rollover is like a 10. I mean, it's way out there. If you're not already playing the credit card signup game, moving money from one brokerage account to another to get signup bonuses, investing in 10 different asset classes, chasing a bunch of factors in your portfolio, and managing rental properties, I don't see why you'd go to this much trouble.
Essentially, what you're doing is investing something less than $35,000—let's call it $15,000 at the start of the 15-year period—in a tax-protected account for an additional 15-20 years instead of in a taxable account. Assuming you're investing pretty tax-efficiently otherwise, I figure this is probably worth about $8,000 more over two decades. If you want to go through all that hassle over the next 15-20 years AND expect to still have enough earned income between year 15 and year 20 that you will still qualify to make Roth IRA contributions but not so much that you will need to make them via the Backdoor Roth IRA process, then knock yourself out.
I won't be doing it for myself. But I might let my kids use their unused 529 money to make Roth IRA contributions for a few years.
I think it's fine to overfund a 529, but I would really only do it if you're planning to help pay for the grandkids' educations too—not to help your kids (or yourself) save for retirement.
Are you going to take advantage of this new 529 to Roth IRA rollover? Do you see this as being a valuable tool for high income earners? What about their children? Comment below!