Law Allows 529 College Savings Transfers to Roth IRAs

• Lifetime limit: Up to $35,000 can be transferred from a 529 plan to a Roth IRA per beneficiary
• Annual transfer limit: The transfer amount cannot exceed the Roth IRA annual contribution limit, which is $7,000 in 2024 for those under age 50
• Account requirements: The 529 plan must be at least 15 years old, and contributions made in the last five years are ineligible for transfer
• Income flexibility: Unlike regular Roth contributions, these rollovers do not have income restrictions for eligibility
• State tax implications: Some states may impose taxes on these transfers, potentially complicating the process

The new law allows for tax-free and penalty-free transfers from 529 plans to Roth IRAs under certain conditions. This move is intended to help account holders avoid the taxes and penalties that usually apply to non-qualified withdrawals from 529 accounts. While the federal law simplifies the rollover process, uncertainties remain, particularly regarding the detailed execution of these transfers and how they interact with state laws, which may still impose taxes on the rollover gains.

Implications for retirement savers

This new option offers a way to repurpose leftover college funds towards retirement savings, potentially giving younger beneficiaries a head start on building their retirement nest egg. It allows these funds to grow tax-free within a Roth IRA, providing more flexibility compared to keeping the money in a 529 plan. However, the limitations on how much can be transferred annually and in terms of lifetime could restrict the immediate benefits of this rollover option. Additionally, the 15-year rule and exclusion of recent contributions create complexities that may deter some savers.

Financial advisors and industry experts advise caution, as the IRS has yet to clarify many aspects of the law. For example, questions remain about how the 15-year rule applies when changing beneficiaries or rolling over 529 accounts between states. Experts also highlight the importance of consulting a qualified tax professional before proceeding, as states may have their own rules that could impact the tax-free nature of these transfers.

The introduction of 529-to-Roth IRA rollovers offers a unique opportunity to bolster retirement savings, but it also requires careful consideration of broader retirement strategies, such as the 4% rule for withdrawals. This rule suggests that retirees can safely withdraw 4% of their retirement savings annually, adjusting for inflation, to ensure their funds last throughout retirement. By transferring unused 529 funds to a Roth IRA, beneficiaries could potentially enhance their retirement portfolios, allowing for steady, tax-free growth that supports a sustainable withdrawal rate, similar to the 4% guideline. 

However, just like the 4% rule itself, the new rollover option is not without risks and uncertainties, especially given the current ambiguities in how these transfers will be regulated and taxed at the state level. Thus, savers must weigh these factors carefully, ideally in consultation with a financial advisor, to ensure their long-term financial strategies align with both new opportunities and established retirement planning principles.

So, while the new 529-to-Roth IRA rollover provision offers a compelling opportunity to repurpose unused college savings, it is not without its challenges. The decision to transfer funds should be made carefully, considering the complexities and potential state tax implications. For those looking to maximize the benefit of this law, consulting with a financial advisor is essential to navigate the uncertainties and ensure compliance with both federal and state regulations.