New Year, New Rules for 529 Accounts. Here’s How to Maximize Your Investment.
Credit: Image Credit: Vstock LLC / VStock / Getty Images- New rules allow a portion of funds in 529 college savings accounts to be rolled over into a Roth individual retirement account (IRA) account.
- Before, account funds not used for qualified education expenses would face taxes and a 10% penalty fee.
- Now, up to $35,000 can be rolled over into a Roth IRA, allowing students and parents more flexibility when saving for postsecondary education.
Last year, grandparent-owned 529 savings accounts were removed from Free Application for Federal Student Aid (FAFSA) rules. This year, even more changes will allow those saving for their future to maximize their investment, including rolling over a portion of funds stored in 529 accounts to a Roth individual retirement account (IRA).
529 savings plans are tax-advantaged investment accounts designed to encourage saving for future education expenses. All 50 states and the District of Columbia sponsor at least one type of 529 plan with varying restrictions and tax benefits.
All earnings from a 529 account are tax-free when used for qualified educational purposes including tuition, fees, and textbooks. However, if a student is awarded a scholarship or changes their educational path, funds that were previously set aside in a 529 account for postsecondary education would be taxed and penalized if withdrawn for nonqualified expenses.
Now, due to a provision in the SECURE 2.0 Act, federal legislation passed in 2022 to encourage saving for retirement, 529 funds can be rolled over to a Roth IRA account without suffering the taxes and penalties that usually accompany nonqualified withdrawals.
“It’s another way to deal with leftover money in your 529 plan, meaning you no longer have to worry all that much about if you save for college or if you save for retirement. You can save for college, and if there’s money left over, you can put it into a retirement plan,” Mark Kantrowitz, financial aid expert and author of “How to Appeal for More Financial Aid,” told BestColleges.
Individuals who own a 529 college savings plan can transfer up to $35,000 from their account to a Roth IRA. However, the new advantage comes with several limits, Kantrowitz said.
The owner of the Roth IRA must be the beneficiary of the 529 account, and the 529 plan used must be at least 15 years old before rollovers can occur.
Additionally, rollovers are subject to the maximum contribution limit for Roth IRAs, up to $7,000 for investors 50 and younger for 2024. Funds transferred must have existed in the 529 plan for at least five years.
Kantrowitz points out that with the contribution limit, it would take at least five years to roll over the maximum amount of funds to a Roth IRA. Additionally, the $7,000 limit includes funds rolled over and cash contributions to an individual’s Roth IRA.
Income limits of Roth IRAs are also waived in a 529-to-Roth rollover. However, contributions from a 529 account won’t be able to be made until the beneficiary has an earned income equal to the amount they are transferring over that year.
Partnered with recent changes, including FAFSA rules that allow non-parent and student-owned 529 accounts to no longer have any impact on financial aid eligibility, makes the 529 accounts an extremely desirable option to save for postsecondary education.
“529 plans in general are the best way to save for a college education,” Kantrowitz said. “They have both tax and financial aid advantages, and the financial aid advantages got even better this year.”