For more than 20 years, parents have used 529 plans as a way to save for their children’s college expenses. These accounts offer the benefit of tax-deferred growth and allow investment earnings to be withdrawn tax-free for qualified education expenses. What some parents don’t expect when they open these accounts, however, is how to manage a remaining balance if their child decides not to go to college, chooses a less expensive school, or receives a scholarship. Although options have existed to manage excess balances in the past, recent legislation has introduced a new strategy that can help reduce 529 plan balances while saving for a child’s retirement.  

529 plans are investment accounts that offer certain tax advantages when used to pay for qualified education expenses such as tuition, room and board, fees, and certain additional expenses. These accounts are funded with after-tax dollars and most plans offer a variety of investment options including static model portfolios, ETF and mutual fund style investments, and age-based enrollment date funds. Investment growth is not taxed inside of a 529 plan and withdrawals for qualified education expenses are tax free. When you make a non-qualified withdrawal, however, the earnings portion will be subject to income tax plus a 10% penalty.  

Roth IRAs are individual retirement accounts that are funded with after-tax dollars up to an annual limit ($7,000 in 2024). These accounts can be invested in a wide range of investment options such as individual stocks, bonds, ETFs, and mutual funds. Roth IRAs also offer tax-deferred growth on investment assets and earnings can be withdrawn tax-free for account holders age 59 ½ and older who have maintained the account for at least 5 years.  

Starting in January 2024, the SECURE Act 2.0 offers a provision that allows for a lifetime maximum rollover of up to a $35,000 in unused 529 plan funds to a Roth IRA for the 529 plan beneficiary. Annual rollovers are limited to the lesser of the annual Roth IRA contribution limit or the beneficiary’s earned income. This means that if the beneficiary is not working, they would not meet the eligibility criteria. Additionally, to qualify, the following restrictions must be met: 

• The 529 plan account has to be open for a minimum of 15 years.  
• Contributions and earnings are required to be in the 529 plan for at least 5 years before being rolled over.  
• If the beneficiary makes any IRA contribution in a given year, the 529 plan to Roth IRA rollover contribution is reduced by the amount of that contribution.  
• Rollovers must be a trustee-to-trustee transfer from the 529 plan to the Roth IRA. That is, you cannot take a check from the 529 plan to deposit into the Roth IRA. 

Jack and Jill established a 529 plan for their son Bill. After funding Bill’s college expenses, they realize that Bill’s 529 plan has a remaining balance of $35,000. To help Bill start saving for retirement, Jack and Jill decide to transfer the 529 plan funds to a Roth IRA. Starting in 2024, they instruct the 529 plan trustee to direct $7,000 of 529 plan assets to Bill’s Roth IRA. After 5 years of rollovers, Jack and Jill have transferred the full $35,000 lifetime rollover amount to their son’s Roth IRA—helping to prepare him for future retirement success. Please note, this example assumes no account growth for illustrative purposes.  

Before deciding to pursue the 529 plan to Roth IRA rollover strategy, it is important to know that certain details surrounding the legislation remain unclear. For instance, the IRS has not yet issued guidance on whether the 15–year clock would reset each time there is a change to the 529 plan beneficiary. Additionally, some states may choose not to conform with the federal tax treatment of 529 plan rollovers. Therefore, while the federal government may permit tax free rollovers to Roth IRAs, your state may impose state taxes. 

Before rolling funds to a Roth IRA, it is important to consider if this strategy is the best option for achieving your goals. Additional strategies include:  

• Scholarship Withdrawals. For students receiving a scholarship, assets up to the amount of the scholarship can be withdrawn from the 529 plan in the same year the scholarship is received without having to pay a 10% penalty. Withdrawn contributions are not subject to tax, but the earnings are taxed at ordinary federal and state tax rates.
• Student Loan Repayment. Up to $10,000 in student loans for the account beneficiary and each of their siblings can be repaid with 529 plan assets without triggering a 10% penalty. Some states, however, will tax the earnings withdrawn from the 529 plan account.  
• Reassign to Another Beneficiary. For families with multiple children, parents can change the 529 plan beneficiary to another child (or other qualified family member) and use the funds to help pay for their college costs.  
• Keep the Account for Future Grandchildren. Lastly, consider changing the beneficiary to yourself and maintaining the account balance for the education costs of future generations.  

While you may not intend to overfund a 529 plan, it is important to understand the available options if the situation arises. In light of the new 529 plan to Roth IRA rollover rule, if you have remaining 529 plan assets, we recommend discussing your options with your Aldrich Wealth financial advisor to formulate a strategy for managing your 529 plan balance in an efficient and tax-friendly manner.