Summary/TL;DR
The SECURE Act 2.0 allows owners of 529 accounts to rollover up to $35,000 of unused funds to a Roth IRA for the account beneficiary. For this to be allowed, a myriad of rules must be followed. While these rules can certainly complicate things, the new 529-to-Roth rollover is a great option under the right circumstances.
Introduction
At the end of 2022, Congress passed the SECURE Act 2.0, a sweeping piece of legislation that did much to change the retirement landscape. Included in the SECURE Act 2.0 is a provision that allows owners of 529 educational savings plans to rollover up to $35,000 of plan assets into a Roth IRA for their child. To many, this is far favorable to the other relatively inflexible options that they face if they have 529 assets left over at the end of their child’s college career. This provision, however, doesn’t come without its own set of rules that must be followed, rules that this post is dedicated to explaining.
The 529-to-Roth Rollover
The SECURE Act 2.0 allows transfers to a Roth IRA in the name of the 529 beneficiary up to a lifetime limit of $35,000. There are a couple of very stringent rules, however, that must be followed for this to be allowed.
The 15-Year Rule
First, the 529 plan must have been held in the beneficiary’s name for at least 15 years. In other words, you can’t just open a brand new 529, stuff $35,000 in it, and proceed to roll it over to a Roth IRA for your child the very next day. This rule is meant to give parents an additional option for funds leftover after a long time of saving for their child.
It’s also important to emphasize that this rule is not that the 529 has simply been “operative” for 15 years. It is that the 529 has been operative in the name of a specific beneficiary for 15 years. This provision effectively eliminates a potential loophole in which a 529 that had been opened for 15 years could continuously be rolled over to 529s for siblings/family members and have assets slowly emptied into Roth IRAs for those other individuals. In effect, therefore, the 15-year rule “resets” every time the 529 is rolled over to a new beneficiary.
The Contribution Limit Rule
Unfortunately, taking advantage of this new provision is not as simple as rolling over a lump sum of $35,000 of leftover 529 funds into a Roth IRA. Any rollover to a Roth IRA from a 529 will be subject to the annual Roth IRA contribution limits, currently $7,000 for individuals under the age of 50. In other words, 529 owners are only allowed to rollover $7,000 per year to a Roth IRA up to a lifetime limit of $35,000, meaning that it would currently take 5 years for the limit to be reached.
The 5-Year Rule
The last rule to be discussed is that any contributions made to the 529 from within the past 5 years are not eligible for a Roth rollover. This prevents the 529 owner from making additional contributions to the 529 towards the end of their child’s educational career solely for the purpose of making Roth IRA rollovers.
For example, let’s suppose you had a 529 for your child’s entire life and they are about to finish college. The balance of the 529 is $10,000 at the time you hear of this new law, and you hastily make a $25,000 contribution in order to rollover the lifetime maximum of $35,000 to a Roth IRA for your child. Due to the 5-Year Rule, however, this $25,000 would not be eligible for the Roth rollover option for 5 more years.
Conclusion
The 529-to-Roth rollover, while a great new option for 529 owners, carries a myriad of rules that must be navigated to be successfully implemented. Due to the lifetime contribution limit attached to this rule, it also won’t be a sufficient option for 529 owners with more than $35,000 to spare in their child’s 529. It is, however, a welcome addition to the relatively thin list of penalty-free transactions that can be made from a 529 after a child’s college education is complete.
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