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The 529 education savings plan is getting a lot more interesting in 2024. At that point unused money in a 529 plan can start to be converted into a Roth IRA, eliminating one of the major defects in the education savings plan: the possibility of money being stranded there.
This new feature makes “funding a 529 plan even more attractive, even with many of its limitations,” says Nicholas Yeomans, CFP, president of Yeomans Consulting Group in the Atlanta area.
It’s good news for the 529’s users, but they’ll need to know the fine print on the process. Here are the details on converting a 529 plan to a Roth IRA and what you need to know.
How to convert a 529 plan to a Roth IRA
The SECURE Act 2.0 has shaken up a number of government-sponsored financial plans, not least of which is the 529 education savings plan. For these plans, the big change means that contributions, which are made on an after-tax basis, can be converted in 2024 and after to a Roth IRA, which is also funded with after-tax money. Ordinarily, if you didn’t use the money on education expenses and withdrew it, you’d owe taxes on the capital gains and a penalty, too.
Beneficiaries of a 529 plan will be able to convert a lifetime total of $35,000 from a 529 plan to a Roth IRA without incurring taxes or penalties. To do so, participants will have to follow a few key rules, including:
- Conversions in a given year are limited to that year’s IRA contribution limit.
- The 529 plan must have been opened for at least 15 years before a conversion.
- Any money converted to a Roth IRA cannot exceed contributions and earnings on them in the five years prior to the conversion date.
- The owner of the Roth IRA must be the same as the 529 plan’s beneficiary.
The last rule may be easier to follow than it sounds at first. The owner of a 529 plan can change the beneficiary to an eligible individual easily enough by contacting the plan’s administrator.
“Unused dollars for education can now fund retirement – tax-free,” says Yeomans.
Pros and cons of converting a 529 to a Roth IRA
Pros of converting a 529
- Puts stranded 529 funds in a Roth IRA tax-free: This biggest advantage of a conversion is that you can repurpose funds that may have been previously stranded in a 529 plan and do so tax- and penalty-free.
- Can be invested anywhere in a Roth IRA: Contributions to a 529 plan are limited to that plan’s investment options, so you may not be able to invest in what you really want. With a conversion to a Roth IRA, you can invest in whatever you’d like.
- Can jumpstart a child’s retirement savings: Any leftover money in a 529 plan can be used to help a child get a good start on tax-free retirement savings.
Cons of converting a 529
- Cannot be undone: “Once the money comes out of the 529 plan and goes into the Roth IRA, as we understand it today, you cannot roll it back into a 529 plan,” says Yeomans.
- Conversion amounts are limited to annual contributions: Any conversion amount is limited to that year’s IRA maximum annual contribution, so you’re not able to double-dip with a maximum 529 plan conversion and a maximum regular contribution to the IRA.
- Long lead time before converting: The conversion requires the account to be open for at least 15 years before a conversion can be made, meaning you need to plan ahead. Even just opening a new account today and starting to fund it could get the clock ticking.
What to watch out for when converting a 529 plan to a Roth IRA
If you’re contemplating converting a 529 plan to a Roth IRA, you’ll want to pay attention to a few other issues surrounding the conversion:
- Conversions can start in 2024: The ability to convert a 529 plan won’t kick in until 2024, so you’ll be unable to do anything before then.
- Advisors and others may be unaware: This change is new, meaning some advisors and other professionals may not know exactly how to process a conversion. “Many custodians are having to put in place new systems and processes to account for these plan conversions,” says Yeomans. “This possibly means many professionals on the other end of the phone line that might give you direction still might need to get clarity in assisting you with these conversions.”
- Rules and features may still change: The IRS wants to prevent people from gaming the system, so it may yet change how a conversion is implemented and the rules around it, as they receive requests for clarification from financial and tax experts, says Yeomans.
Before you make a conversion be sure that you fully understand the rules around the process.
With this new change a 529 plan can be a great way to fund your children’s higher education and get them started on a few years’ worth of retirement contributions. This change provides even more incentive to fund your child’s education, but with that required 15-year lead time before you can convert, it’s important to plan ahead and get started early.