Transferring Funds from a 529 to a Roth IRA

July 25, 2024  | By David Lowe

A 529 account can be a great tool for saving for college. Investment growth is tax-free, and so are the withdrawals (if used for qualifying education expenses). In many parts of the country, state income tax deductions are available for 529 contributions.

Those all are reasons to contribute to a 529 account early and often. What happens, though, if a 529 is so well funded that it pays for all of the beneficiary’s education goals and still has leftover money?

Drawing from a 529 for a non-qualified use – such as starting a business or buying a car – can result in income tax and penalties. Until recently, the main way to avoid those unwanted tax bills was to move unused 529 funds to another 529 beneficiary, such as a sibling or other close family member. That’s a good option if a family knows it will fund other loved ones’ educational goals. But what if a higher financial priority for you is using your child’s surplus 529 funds to give him or her a head start toward retirement?

Thanks to the SECURE 2.0 Act, there is a new option that creates additional flexibility. This is the option to move unused 529 funds to a Roth IRA. That’s a great way to boost the Roth account, building a bigger tax-free income source for retirement.

It all sounds simple enough. However, the world seems to get more complex all the time. As with many things related to personal finances, specific conditions apply. Here are key rules for moving funds from a 529 account to a Roth IRA.

Rule #1: The 529 account must have been open for at least 15 years.

If you have an account with my529 (Austin Wealth Management’s recommendation for most clients), the account creation date has been listed on each quarterly statement since late 2023.

If your current account was rolled over from another 529 plan, plan to contact the original 529 provider to verify the account creation date.

There are many lingering questions related to the 15-year rule. According to my529’s Frequently Asked Questions page for 529-to-Roth transfers, plan providers still are awaiting IRS clarification on the following:

• If a 529 account was opened with a rollover from another plan, does that reset the 15-year clock?
• If the 529 beneficiary or account owner changes, does the 15-year clock reset?
• If you close and then reopen a 529 account, does that reset the 15-year clock?

Rule #2: The 529 beneficiary must match the owner of the Roth IRA account that receives the 529 funds.

For example, imagine you have two sons and a daughter – with a 529 account for each of them. If your daughter has a Roth IRA account, you can move funds from her 529 to her Roth IRA. On the other hand, you can’t transfer money from her 529 to your Roth IRA – or to her brothers’ Roth IRAs.

Rule #3: The dollar amount of the rollover is limited.

Limitations apply per year, for the lifetime total rollover, and based on the five-year period before the rollover.

Per year:

• The 529 beneficiary must have what the IRS classifies as “earned income” in the year that funds move from a 529 account to a Roth IRA.
• The 529-to-Roth rollover can’t exceed the 529 beneficiary’s earned income for the year. For example, imagine an 18-year-old who decided not to attend college and who earned $5,000 for the year through various jobs. For that year, the 18-year-old could move only $5,000 from his or her 529 account to his/her Roth IRA.
• The yearly Roth IRA contribution limits apply. For 2024, the contribution limit is $7,000 for those younger than 50. Therefore, for 2024, a 529 beneficiary can move no more than $7,000 to his/her Roth IRA. This assumes, of course, that earned income for the year is at least $7,000.
• The maximum 529-to-Roth rollover for each year must deduct any amount the taxpayer already contributed to the Roth IRA as a “normal” contribution. For example, if a 529 beneficiary earns $7,000 or more in 2024 and makes $1,000 of contributions directly to a Roth IRA, the maximum 529-to-Roth rollover for the year would be $6,000.

Lifetime total rollover: This is limited to $35,000. Therefore, it could take several years to move the full $35,000 from the 529 to the Roth IRA. Remember, the current annual limit is $7,000. The annual maximum may increase slightly based on the limits the IRS sets for 2025 and beyond.

Five-year rule: This applies in addition to the 15-year rule previously discussed for the age of the 529 account.

As quoted in this Kitces.com blog post, the actual SECURE 2.0 text states that rollovers from a 529 to a Roth IRA can’t “exceed the aggregate amount contributed to the program (and earnings attributable thereto) before the 5-year period ending on the date of the distribution.” That’s a mouthful!

Here it is in plain English, according to the Kitces post and the Journal of Accountancy: Don’t transfer funds contributed in the last five years (or the earnings on those funds).

Another way to think about it: if you want to be extremely safe, wait at least five years from the last contribution before making a 529-to-Roth rollover. If you last contributed to the 529 when your child was a high school senior, and the child now is 25 and finished with higher education, you should be all set. For the more complex questions about the 529-to-Roth rollover when you have made recent contributions, please consult your CPA or other tax advisor.

The five-year rule has another implication. If a family expects to use the 529-to-Roth strategy, that could be one additional reason to fund a 529 with large lump sums while the child is young (perhaps even before kindergarten) – instead of contributing smaller amounts all the way until college begins. Plus, in states like Texas that have no state income tax, there is no tax motivation for making annual contributions. Instead of contributing a smaller amount over a longer time, making a large 529 lump sum when the child is very young gives the account the maximum time to grow (with no federal income tax on earnings). This also will make it easier to move funds from the child’s 529 to the child’s Roth IRA later in life, if desired.

Rule #4: The funds must flow directly from the 529 to the Roth IRA in a “trustee to trustee transfer.”

In other words, an account owner may not withdraw funds for themselves from the 529 and then deposit the funds in a Roth IRA.

Here’s additional guidance from my529: “Account owners must establish a Roth IRA account before requesting a rollover. If the Roth IRA trustee requires a Letter of Acceptance, the account owner will need to direct them to send that letter to my529 before my529 can rollover the funds. Funds can only be sent to the trustee.”

To start the process of moving money from a my529 account to a Roth IRA, use Form 310: Roth IRA Rollover Request.

Additional items to consider:

• If the funds move from the 529 to the Roth IRA after December 31, 2024 and before the April 15, 2025 tax filing deadline, the account owner may elect to classify the rollover as a 2024 contribution. According to my529, “Indicate to your Roth IRA trustee which year they should record your IRA contribution. Please consult a tax advisor for more information specific to your situation.”
• If you previously received a state income tax credit or deduction for a 529 contribution, you may need to pay it back if you perform a 529-to-Roth rollover. It depends on whether your state treats 529-to-Roth rollovers the same way federal law does (as a qualified, non-taxable movement of money). According to this site, 10 states – plus the District of Columbia – may “recapture” previous state tax credits or deductions. The tax treatment is unclear for seven other states. This obviously is a complex area of tax law, so please check with your CPA or other tax advisor before rolling funds from a 529 to a Roth IRA.
• The Roth IRA custodian (Charles Schwab, Fidelity, Vanguard, etc.) may have its own specific rules about rolling funds from a 529 to a Roth IRA. As my529 advises, “If your rollover does not meet the Roth IRA trustee’s rules and regulations, the rollover could be rejected. You should confirm with your Roth IRA trustee that your rollover will meet its rules and regulations prior to requesting a rollover. You may also wish to verify with your Roth IRA trustee how the rollover will be handled. Rollover requests that are rejected by the Roth IRA trustee and returned to my529 will be treated as new contributions by my529.”

Although the rules are complex, the new 529-to-Roth option is designed to give investors additional flexibility. The new rollover option also can reduce concerns about incurring taxes and penalties when moving money out of an overfunded 529. 

If you have a 529 surplus and think you could benefit from a rollover to a Roth IRA, please contact your financial advisor to discuss your specific situation.