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Unused 529 Plans can be Rolled to Roth IRAs

March 09, 2023

SECURE Act 2.0 paved the way to repurpose unused 529 plans, and the headline looks great. Like so many rules, the headline gets the attention, but the details get overlooked. While this is a good step in the right direction, there’s a catch. Actually, there are six catches. 

There are some who theorize that this is the government’s way of dipping their toe in the water on this rule; that maybe the government is testing out this idea before gifting it to the masses. While I’m hopeful that idea has some weight to it, I’m not holding my breath. In the meantime, we can utilize this rule, where applicable, for those families who can find it useful.

Here are the basic guidelines for rolling unused 529 Plans into Roth IRAs. Not one or two, but all six of these guidelines must be met to proceed in rolling 529 plans to a Roth IRA. Think of each guideline as a checkpoint or a hurdle to topple before moving to the next guideline. The guidelines are outlined below:

1: The unused 529 Plan must be rolled into the beneficiary’s Roth IRA. Funding a 529 plan is treated the same as gifting money. In fact, when a parent or grandparent establishes a 529 Plan for  child/grandchild, the 529 Plan is not listed on their balance sheet. The funds belong to the beneficiary. The rules and regulations regarding minors owning funds plus the restrictions of the 529 Plan make it feasible for the gift to be made to children. So when the unused funds are eventually rolled to a Roth IRA, the money doesn’t belong to the donor, it belongs to the beneficiary, so it makes sense that the Roth IRA belongs to the beneficiary of the 529 Plan.

2: The 529 Plan must be in existence for at least 15 years. The purpose of the 529 Plan is to save for education, so the 15-year timeframe is established to make sure the 529 Plan has a fair shot at providing funds for the intended purpose. I think this is also a stopgap to reduce the possibility of taking advantage of the rule. Only older 529 Plans can be used. The backdoor Roth IRA was established, not by the information in the tax code, but the information left out of the tax code. This seems to be a lesson learned from congress to prevent another backdoor Roth IRA situation, so the 15-year threshold is the way to make sure a 529 Plan isn’t established and then automatically change it to a Roth IRA.

3: The last 5 years of 529 Plan contributions are not eligible for the Roth IRA rollover. This is somewhat of an extension of the 15-year establishment rule. This seems to make sure someone doesn’t “double-down” on 529 Plan contributions to gather a few extra state income tax deductions before immediately rolling the 529 Plan into a Roth IRA. If a 529 Plan is established for 15 or more years and the last contributions were more than 5 years ago, those final contributions would count towards the rollover. It’s not the last 5 contributions – it’s the contributions made in the last 5 years on the year of the rollover.

4: There is a $35,000 lifetime limitation. I assume this is a lifetime limitation per beneficiary, but it isn’t fully clear yet. This is where the guidelines begin to get even more restrictive for two reasons: 1) While $35,000 isn’t anything to ignore, it isn’t life-changing money when saving for retirement, and 2) If a 529 Plan is over-funded and has significant unused funds, $35,000 won’t be enough to truly make a difference in some situations. I’ve seen 529 Plans with hundreds-of-thousands of dollars in them, and this kind of over-funding generally occurs when a parent or grandparent understand the rules of 529 Plan funds or doesn’t realize alternatives to 529 Plans exist. Having healthy 529 Plans is not a bad thing in the least, but there are ways to diversify the account style of 529 Plans to retain control of the funds and to reduce regulation over the funds.

5: On top of the $35,000 lifetime limitation, the maximum amount that can be rolled to a Roth IRA per year is the IRA contribution limits for that year. Currently, the IRA contribution limit is $6,500 (with an additional $1,000 allowance for individuals age 50 and older). Rolling $6,500 from a 529 Plan to a Roth IRA each year, it would take 6 years to reach the $35,000 lifetime limitation. This makes rollover period elongated and somewhat more burdensome. The 529-to-Roth-IRA process has a minimum timeframe of 21 years: At least 15 years for the 529 Plan to be in existence plus 6 years for the rollover to take place in $6,500 increments.

6: The 529 Plan rollover to a Roth IRA is only allowed if the beneficiary is allowed to contribute to a Roth IRA based on income limitations anyway. The current income restrictions for funding a Roth IRA are a range of incomes that determines the amount of Roth IRA that can be contributed. While rolling unused funds from a 529 Plan to a Roth IRA is certainly a useful tool (don’t get me wrong here!), I feel like this is such a limiting factor. The individuals who have unused 529 plans either didn’t attend higher education, had way too much money saved on their behalf, or received significant scholarships. It’s possible that high-paying jobs may be set aside through family businesses for those who had too much money saved on their behalf and high-paying jobs are often being offered to those who received significant scholarships. While not all these assumptions are true, the majority of those who have leftover 529 Plan funds will likely not be able to utilize the rollover provision anyway. 

The reality is that this provision – rolling unused 529 plans into Roth IRAs – could be significantly abused if not restricted and monitored correctly. Some 529 plans allow for state income tax deductions, and some allow for incredibly high contribution limits. Combining those two factors into Roth IRAs could surely leave some exposure for higher-than-normal Roth IRA contributions with nominal tax deductions. As such, I understand the scrutiny around carefully limiting this rule, but with the way it is currently set up, I’d be surprised if this provision makes a significant impact on the American people. If the restrictions are loosened and the impact is expanded, it could be a game-changer for those saving for college.