Maximizing Your 529 Plan: New Rules and Smart Strategies

Your ambitious in-laws generously funded a 529 account to help your little one finance an Ivy League education. Then your child opted for a less-expensive state school instead. Is there any way to use the leftover funds in the 529 account without paying penalties and taxes? New rules make it possible to roll over unused 529 plan funds into a Roth IRA account for the same beneficiary.

Understanding the 529 Plan

A 529 plan is an investment account that allows families to save tax-advantaged funds for college, graduate school, or K-12 tuition. A parent or grandparent (the account owner) typically opens a 529 account for a child or grandchild (the beneficiary). Rolling unused 529 plan funds into a Roth IRA can help the beneficiary build a nest egg for a future beyond their education. You might decide to move 529 funds into a Roth IRA if you don’t expect the beneficiary or any other family members to need the money for education-related expenses in the future. Here’s how the process works.

New 529 Plan Rules

Currently, distributions from 529 plans can only be used for qualifying educational expenses, which include:

• College or postgraduate tuition, room and board, and required fees, books, equipment, and supplies
• Certain apprenticeship, vocational, or trade programs
• Up to $10,000 of K-12 private school tuition annually
• Repaying up to $10,000 in qualifying student loans for the 529 plan’s beneficiary or a sibling

If you use 529 plan funds for anything else, you’ll pay a 10% penalty fee and taxes on the earnings of the amount withdrawn.

The Consolidated Appropriations Act that funded the federal government through the 2023 fiscal year contained a section called SECURE 2.0 which eased these restrictions. Section 126 of the new law changed the Internal Revenue Code governing 529 plan distributions. Under the new rules, plan beneficiaries can roll over up to $35,000 in unused funds from their 529 accounts to Roth IRAs over their lifetimes, beginning January 1, 2024.

Options for Unused 529 Plan Funds

If your 529 plan’s original beneficiary decides not to use the money for qualifying educational expenses, you have other alternatives:

• Change the plan beneficiary to another family member, such as yourself, a sibling, or a parent, who you know will use the funds. (Check eligible educational programs.) You can change plan beneficiaries once a year.
• Sit tight and leave the money where it is. One day, you might want to get an advanced degree, change careers, or transfer the plan to a grandchild who doesn’t exist yet.

If these options don’t make sense for you, rolling over 529 plan funds into a Roth IRA can give the beneficiary a flying start at saving for retirement or other goals.

How to Roll Over Unused 529 Plan Funds

Before rolling over unused money from a 529 plan into a Roth IRA, make sure your plan and beneficiary meet the following requirements:

• The 529 plan must have been open for a minimum of 15 years. If the plan has been open for 10 years, for instance, you’d need to wait five more years before rolling over any funds.
• The Roth IRA must be in the 529 plan beneficiary’s name.
• Contributions to the 529 plan made in the past five years, and any earnings on those contributions, cannot be rolled over.
• An individual’s total annual IRA contributions (including rollovers) can’t exceed the annual limit, which is $6,500 for 2023 ($7,500 for those age 50 and over).
• The beneficiary can’t make any IRA contributions unless they have earned taxable income that year. If this income is less than $6,500, their IRA contributions (including rollovers) are limited to that amount.

Normally, an individual’s modified adjusted gross income (MAGI) affects how much they can contribute to a Roth IRA. These limitations don’t apply to 529 plan rollovers.

Steps to Roll Over Unused 529 Plan Funds

1. Contact the financial institution holding your 529 plan. Make sure your plan and the beneficiary are eligible for a rollover.
2. Select a Roth IRA. If the 529 plan beneficiary doesn’t already have one, you’ll need to open a Roth IRA in their name. The institution holding your 529 account may offer Roth IRAs, or you can open a Roth IRA with a brokerage firm, bank, credit union, or any other financial institution that offers these accounts.
3. Open the Roth IRA. The beneficiary will typically be asked to provide some form of government-issued identification, employment information to confirm their earned income, and their Social Security number.
4. Arrange for the rollover. You can roll over funds beginning January 1, 2024. Contact your 529 plan provider to find out how to proceed. Once the Roth IRA account is open, the money must be transferred directly from the 529 plan to the IRA. If you or your beneficiary receive a check and deposit it in the Roth IRA, you could have to pay taxes and face penalties.
5. Decide how to invest the Roth IRA funds. You’ll typically have the option to choose among various investment vehicles such as stocks, mutual funds, bonds, and exchange-traded funds. Younger investors may benefit from choosing investments with high growth potential, such as stocks, since they have more time to recover from losses before retirement.
6. Continue to roll over funds from the 529 plan every year until you reach the $35,000 limit. A 529 plan beneficiary can roll over up to $35,000 in unused funds over their lifetime, but due to annual IRA contribution limits, it can’t be done all at once.

Is It a Smart Move to Roll Over Unused 529 Plan Funds?

Unused 529 plan funds that aren’t rolled over into another account don’t disappear or expire, so you won’t lose the money. Your account remains open, and you can continue to manage and potentially grow it. Should you roll over the unused funds, or stick with the status quo?

Pros of Rolling Over Unused 529 Plan Funds

• Jump-start the beneficiary’s retirement savings. Rolling over funds into a Roth IRA when the beneficiary is young can give them a head start on a retirement nest egg. According to estimates by Fidelity Investments, a 27-year-old starting with $30,000 in a Roth IRA earning a 7% rate of return could have almost $450,000 in the account by age 67, even without making additional contributions.
• There’s less financial responsibility. You may not want the responsibility of managing a 529 account that no one is using. Moving the money into a Roth IRA for the beneficiary takes this task off your plate.
• Funds in a Roth IRA can be used for more than just retirement. Qualifying beneficiaries may be able to use up to $10,000 of funds in a Roth IRA to make a down payment on a first home without penalties.

Cons of Rolling Over Unused 529 Plan Funds

• The nature of your savings will change. Even if you don’t make additional contributions, your 529 account could grow, helping to finance education for future generations.
• You’ll have to look for other sources to fund education. If you, your beneficiary, or another family member eventually decides to attend a qualifying educational institution, you won’t have 529 funds available to use.

The Bottom Line

A 529 plan can be a great way to help your child, grandchild, or other family member save for college while enjoying tax benefits. But scholarships, life changes, and other factors can leave your 529 account with excess funds that may never be needed. Rolling over that unused 529 money to a Roth IRA in the beneficiary’s name could help them build wealth and save for retirement, giving them a financial leg up as they launch into adulthood.

A good credit score can also give your young adult a financial advantage. Remind your beneficiary of the importance of paying bills on time, keeping debt to a minimum, and regularly checking their credit report. Signing up for free credit monitoring can help your child keep tabs on their credit and get alerts of potential fraud so they can take action.

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