529 Plan to Roth IRA Rollovers: A New Strategy for Early Retirement Savings

In December 2022, a new rule was enacted that opens up an innovative way to fund retirement savings using 529 plans. Starting in 2024, families will be able to roll over up to $35,000 of unused 529 college savings into Roth IRAs for the beneficiary of the plan. With Roth IRAs being one of the most tax-advantaged retirement savings vehicles, this option provides an exciting way to boost long-term savings while maintaining tax efficiency.

Roth IRAs offer tax-free qualified distributions in retirement, making them ideal for long-term retirement planning. By utilizing this new rollover provision, families can help their children jumpstart retirement savings, allowing for decades of potential growth. Below is a review on how this process works, the key eligibility requirements, and some additional considerations for families interested in taking advantage of this new benefit.

The new rule provides a path to move funds from a 529 account into a Roth IRA, but there are several important eligibility requirements to be aware of:

• Beneficiary Specific: The funds can only be rolled over into a Roth IRA for the 529 plan’s beneficiary. If the 529 plan was set up by a parent or guardian, they cannot use the funds for their own retirement; it must go to the designated beneficiary.
• Account Longevity: To qualify, the 529 account must have been open for a minimum of 15 years before any funds can be transferred to a Roth IRA.
• Contribution Restrictions: 529 contributions and earnings from the 5 year period ending on the date of the distribution are not eligible to be moved directly to a Roth IRA.
• Lifetime Limit: There is a lifetime limit of $35,000 per beneficiary for 529-to-Roth rollovers. While this might not cover an entire retirement fund, it provides a solid foundation for future growth.
• Annual Limits: The amount rolled over each year is limited to the annual Roth IRA contribution limit, which is $7,000 in 2024 for those under age 50, and $8,000 for those 50 or older. This amount is reduced by any direct contributions made to traditional or Roth IRAs in that year.
• Earned Income Requirement: The beneficiary must have earned income at least equal to the amount rolled over. However, the usual income limits that restrict direct Roth IRA contributions do not apply to these rollovers.

While the federal rules permit tax-free rollovers from 529 plans to Roth IRAs, the tax treatment at the state level can be more complicated. Some states may require taxpayers to recapture state tax benefits they received for 529 contributions if those funds are transferred to a Roth IRA. For example, states like California, Massachusetts, Michigan, and Minnesota may not recognize the rollover as tax-free. This means that if you live in one of these states, you could owe state taxes on the transferred funds. On the other hand, many states do conform to the federal rules and allow tax-free rollovers. To avoid surprises, it’s best to consult with your 529 plan provider or a tax advisor to understand your state’s stance on these transfers.

Although the new rule is clear on many fronts, there are still some unanswered questions that may require further IRS guidance. Two notable areas of uncertainty include:

• Beneficiary Changes: If the beneficiary of a 529 plan is changed, does the 15-year clock reset? This is important for families that may want to shift the funds to a new beneficiary, such as a sibling.
• Transfers between State 529 Plans: What happens if funds are transferred from one state’s 529 plan to another? Does the original 15-year clock apply, or does it restart based on the new plan’s establishment date? These are important factors to consider, and families should stay tuned for any updates from the IRS as more guidance is provided on these issues.

The ability to roll over unused 529 plan funds to a Roth IRA provides families with greater flexibility in managing their education savings while offering a way to kick start retirement savings for the next generation. Whether you’re looking to minimize tax liabilities, boost long-term savings, or simply take advantage of the opportunity to grow tax-free retirement funds, the 529 to Roth IRA rollover is a powerful strategy. With careful planning and attention to state tax rules, this new option can be a valuable tool in helping beneficiaries build a secure financial future.

Please contact your Oppenheimer Financial Professional for more information regarding 529 Plan to Roth IRA rollovers. If you don’t have one, you can find one in your local area by clicking here.