Should I Rollover “Leftover” 529 Plan Funds to a Roth IRA?

One of the many provisions in the retirement bill known as SECURE 2.0, passed in 2022, is the ability to rollover “leftover” 529 plan funds to a Roth IRA, penalty and tax-free, and with no income limits. This provision became effective on January 1, 2024 and has already generated a lot of interest. It provides a great opportunity to jumpstart retirement savings for children who do not need the leftover funds for education expenses and it’s an effective wealth transfer strategy to boot.

Our initial response to the question posed in the title of this article is that it makes sense to wait for now and allow any leftover 529 plans to continue to grow tax-free, particularly for anyone who resides in a state with a state income tax. The reason is because there are still plenty of unknowns.

Here’s what we know:
• The 529 plan must be under the beneficiary’s name for a minimum of 15 years.
• The 529 plan beneficiary and the Roth IRA owner must be the same.
• Yearly conversions cannot exceed annual Roth IRA contribution limits ($7,000 for 2024) and the Roth IRA owner must have earned income at least equal to the amount converted.
• The lifetime 529 to Roth IRA rollover limit is $35,000. At the current yearly conversion limit ($7,000 for 2024), it would take at least five years to fully convert the $35,000 rollover limit.
• 529 plan contributions (including earnings accrued on those contributions) made in the last five years cannot be transferred to a Roth IRA.
• If the beneficiary makes any IRA contributions in a given year, the eligible 529 to Roth IRA rollover amount is reduced by the size of that contribution. For instance, if the beneficiary contributes $3,000 to an IRA in 2024, the eligible rollover amount decreases to $4,000, based on the 2024 total IRA contribution limit set by the IRS.
• The rollover must be direct (e.g., plan-to-plan or trustee-to-trustee). You cannot take a distribution — a check — from a 529 and send it to a Roth IRA.

While this is a somewhat detailed list, it seems pretty straightforward/manageable and your situation may fit with the requirements.

Here’s what we don’t know:
• If I changed the 529 plan beneficiary at some point in the past, does this restart the 15 year waiting period?
• If I rolled the 529 plan from one state to another at some point in the past, does this restart the 15 year waiting period?
• How can I track the income from contributions made during the past five years?
• If I have more than $35,000 leftover, can I roll that amount over and then change beneficiary to roll the balance over to another beneficiary?
• What are the state income tax implications for completing a 529 plan to Roth IRA rollover?

The last point may be the biggest caveat. We do know that CA, IL, MI & NY are among the states whose laws do not treat transfers as tax-free. CA also imposes a 2.5% on tax on the gains within a plan for distributions not used for qualified education expenses.

Some states may ultimately come around and align themselves to the federal tax treatment. Others may not. And, in some states, you may have to repay any state income tax credits or deductions you received for your contributions to the 529 plan as a result of completing a 529 Plan to Roth IRA rollover.
What you’ll find on most 529 plans with regard to the state income tax issue is a disclaimer to “Consult a Tax Professional”. If you’re reading this article when it was published, then you currently know about as much about this issue as any tax professional does.

We don’t expect clarifications on these issues any time soon. Most states are waiting on the federal government to clarify the unknowns at the federal level. At the federal level, we’ve seen no material progress in Congress, which makes sense considering that 529 plans were conceived to fund college expenses and not as a wealth transfer strategy for wealthier taxpayers.

All of this leads us back to the question of whether you should rollover and leftover 529 plan funds to a Roth IRA.
If you have leftover funds in a 529 plan account and are considering a rollover to a Roth IRA, then you should not change the beneficiary based on what we know. You probably don’t want to leave any more than $35,000 in a 529 plan account (probably better to leave less to account for continued growth) given the maximum rollover amount.

If you live in a state with no state income tax, then you’re in a better position to move forward if you can comply with the above checklist of ‘what we know’. You would not have received any credits or deductions for contributions that have to be paid back as a result.

If you reside in a state with a state income tax, then we think it makes sense to wait and give it some time to see if/when any of the above issues are clarified. It ultimately still may make sense to rollover leftover 529 plan funds to a Roth IRA for the 529 plan beneficiary, even if there are state income taxes to pay. But, for now, there is no deadline to move such funds and you can continue to enjoy tax-free compounding of the funds in your 529 account.
As always, please reach out to your ACM Wealth Advisor if you have any questions.

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