Leftover Money In A 529 Plan? You’ll Soon Have A Nice Option For It

The $1.7 trillion spending bill passed in late December contained some welcome relief for parents with leftover money in 529 college savings plans – and reassurance for those who are saving up but wary of overshooting the objective.

Specifically, people in this situation will soon be able to move 529 money into a Roth IRA. As we’ll describe below, limitations on the maneuver may throw a bit of a wet blanket on you, depending on your particular circumstances. 

529 plans allow savers to put money away for education expenses. There’s no tax deduction for contributions, but money that’s used for qualified expenses comes out tax-free. 

That’s great, but what happens if you end up with more money in a 529 plan than you actually needed to cover your kid’s education costs? If you cash out and don’t use the money for education costs, you’ll be hit with ordinary income taxes on the earnings, plus a 10% penalty.  

Until now, one of the most common tactics for over-saving parents has been naming a new beneficiary for the account and using the money for them. IRS rules give wide latitude for beneficiary changes — allowing a switch to members of the current beneficiary’s family, including parents, siblings, nieces and nephews, aunts, uncles, first cousins and even brothers- and sisters-in-law.  

Another option: the SECURE Act of 2019 lets those with qualified student loans use up to $10,000 in 529 money toward loans taken out for the beneficiary or a beneficiary’s sibling.  

Starting in 2024, however, beneficiaries can roll money from 529 accounts to Roth IRAs without paying taxes or penalties. It’s important to emphasize this treatment is available to the beneficiary — not their parents or other account owner.  

With all of the changes made to 529 plans in the past few years they are now better and more useful than ever

-tax free growth
-State tax deduction for contributions
-use funds for college or primary education
-roll over up to $35k of unused funds to a Roth IRA

— Chris Kimmet, CFP® (@ChrisKimmet) February 9, 2023

The beauty of the move is that qualified Roth IRA withdrawals — after a Roth has been open for five years and the owner is age 59 1/2 — are tax-free. Also, contributions — not earnings — can be withdrawn any time without tax or penalty.  

There are some important limits, however, including: 

• The 529 account must have been open for at least 15 years. Until the IRS posts rules to carry out the new law — SECURE 2.0 — it’s not clear if the 15-year clock will apply to how long the account has been open or how long the beneficiary has been in that role.  
• You can’t roll 529 contributions made in the five years before the rollover, or earnings from those particular contributions. 
• Beneficiaries can roll over a max of $35,000 over their lifetime
• Rollovers are subject to the annual Roth IRA contribution limit. In 2023, that’s $6,500 for those under age 50, and $7,000 for those 50 and older. However, unlike regular Roth contributions, rollovers from 529′s won’t be limited by the beneficiary’s income. 

While the new rule was meant to address accidental surpluses in 529 accounts, some are recommending parents deliberately overfund so they can use the new rule to give their kids a Roth IRA head-start in life. Since there’s no age restriction on a 529, you could even use this maneuver as a backdoor way to fund a Roth for yourself if you’re not otherwise eligible.

However, before you plunge into those strategies, consider the potential that a government that’s over $31 trillion in debt might vaporize these new rules before you have a chance to use them that way.