Transfer of Unused 529 Plans to Roth IRAs

If you created a college savings fund or 529 plan for one of your family members and unused funds remain in the account, this article is for you! Did you know that you can likely repurpose those tax deferred investments for the future? There are some specific guidelines, but we are glad to break down the details for you! Let's dive into the ins-and-outs of this innovative strategy and discover how it could help secure your family’s financial future.

Understanding 529 Plans and Roth IRAs

A 529 plan is a tax-advantaged savings plan designed to help families save for future education expenses such as tuition, room and board, and textbooks. Contributions to a 529 plan grow tax-free, meaning you won't pay taxes on the investment gains, provided the funds are used for qualified educational expenses.

On the other hand, a Roth IRA is a retirement savings account that offers tax-free growth and tax-free withdrawals in retirement. Both accounts offer valuable tax benefits, but they are typically “unlinked” and used for different purposes – until now.

The Opportunity: Unused 529 Plans to Roth IRA¹

If your family member opted not to go to college, went to a local college with a lower cost structure, or did not use the entirety of the funds in the 529 – the funds can now be repurposed for retirement savings. At ClearPlan Wealth Management, we are helping many of our clients explore the transfer of unused 529 plan funds to Roth IRAs. This provides a host of possible benefits and can potentially lay a great foundation for the 529 beneficiaries retirement nest egg. Here's how our firm approaches the process of transferring funds in an unused 529 plan to a Roth IRA:

• We Evaluate Your 529 Plan: Our team of financial advisors will help you assess whether the funds remaining after your child has completed their education are eligible to transfer to a Roth IRA. Strict guidelines apply.
• Understand the Tax Implications: Before proceeding with a 529 to Roth transfer, it is crucial to understand the tax implications. While contributions to a 529 plan are made with after-tax dollars and grow tax-free if used for qualified withdrawals, withdrawals for non-qualified expenses may be subject to income tax and a 10% penalty on the earnings portion. Conversely, Roth IRA contributions are made with after-tax dollars, and qualified withdrawals in retirement are entirely tax-free. We work strategically with your tax advisor to understand these implications and make recommendations based on your individual circumstances.
• Transfer Unused 529 Plan Funds to Roth IRAs: If you have unused 529 plan funds and you are looking to bolster the beneficiary’s retirement savings, there may be an opportunity to transfer those 529 funds to a Roth IRA. This process is tax and penalty free as long as a strict list of requirements are met. Key rules for the transfer include, the owner of the Roth IRA being the original beneficiary of the 529 and, the 529 account being open for 15 years or longer. There are other requirements which are strictly enforced by the IRS. ClearPlan Wealth Management can guide you through the complete process as outlined in Secure act 2.0. Rollover provisions, which became law in December 2022.
• Maximize Tax-Free Growth: Once the funds are in the Roth IRA, they will continue to grow tax-free, just like Roth IRA contributions. Plus, qualified withdrawals in retirement will be entirely tax-free, providing the owner with a valuable source of tax-free income during their retirement years.

The 529 plan must have been open for 15 or more years. Contributions and associated earnings must have been in the 529 plan account for at least 5 years to qualify for rollover to a ROTH IRA Contributions and associated earnings made within the last 5 years are ineligible. A lifetime maximum of $35,000 per beneficiary can be rolled over from a 529 plan to a ROTH IRA. The 529 to ROTH IRA rollover is subject to the IRA annual contribution limit for the taxable year applicable to the beneficiary for all individual retirement plans maintained for the benefit of the beneficiary (the total amount that can be rolled over from a 529 pan to a ROTH IRA annually is the annual IRA contribution limit of the year, reduced by the total of any other IRA contributions made by the beneficiary that year. The beneficiary must have earned income sufficient to make the contribution into the ROTH IRA.

The Benefits of Transferring Unused 529 Plans to Roth IRAs

Each client situation is different. The financial advisors at ClearPlan Wealth Management meet with you to discuss your unique situation and your overall goals. Some of the benefits of transferring unused 529 plan funds to Roth IRAs often include:

• Tax-Free Growth: By transferring unused 529 plan funds to Roth IRAs, the owner can take advantage of tax-free growth on their retirement savings. This means that any investment gains within the Roth IRA will grow tax-free and can be withdrawn tax-free in retirement, providing the owner with a valuable source of tax-free income.
• Flexibility: Roth IRAs offer greater flexibility than 529 plans when it comes to how you can use the funds. While 529 plans are designed specifically for education expenses, Roth IRAs can be used for a variety of purposes, including retirement income, healthcare expenses, and even legacy planning.
• Estate Planning Benefits: Transferring unused 529 plan funds to Roth IRAs can also offer estate planning benefits. Roth IRAs are not subject to required minimum distributions (RMDs) during the owner’s lifetime, allowing the owner to leave the funds untouched for as long as the owner lives. As the Roth IRA is passed to beneficiaries, the account can be held and allowed to grow for an additional 10 years, at which time the account assets are to be fully distributed and used as the owner sees fit. Qualified withdrawals from Roth IRAs are tax-free for your beneficiaries, providing them with a valuable inheritance.

Considerations Before Transferring Unused 529 Plans to Roth IRAs

While transferring unused 529 plan funds to Roth IRAs can offer numerous benefits, it is essential to discuss your situation with a trusted financial advisor at ClearPlan Wealth Management to consider:

• Tax Implications: Strict adherence to 529 transfer rules is mandated by the IRS. Violation of these rules may result in the transfer not only being taxable but may also include a 10% tax penalty. Our ClearPlan Wealth Management team can work with you and your tax advisor to understand the guidelines of the transfer and ensure proper execution.
• Investment Strategy: Once the funds are in the Roth IRA, the owner may want to ensure they are invested appropriately for retirement goals and risk tolerance. We will help develop an investment strategy that aligns with the owners’ objectives and helps maximize the growth potential of the retirement savings.
• Understanding the rules of a Roth IRA: Prior to attaining the age of 59 ½, an account owner can always withdraw contributions from a Roth IRA with no penalty, however the earnings may be subject to taxes and/or penalties. At age 59½, the owner can withdraw both contributions and earnings with no penalty, provided that the Roth IRA has been open for at least five tax years.

Transferring unused 529 plan funds to a Roth IRA offers some unique opportunities to repurpose college savings for retirement savings and unlock a host of possible tax advantages along the way. By strategically leveraging the tax benefits of a Roth IRA with the goal to maximize tax-free growth potential, the owner can potentially add to their retirement nest egg, and likely create a more secure financial future and legacy for your family. As with any financial strategy, it's essential to consult with a qualified financial advisor or tax professional to ensure the strategy aligns with the owner’s individual circumstances and long-term goals.

Is Your Financial Advisor Proactively Engaged?

Has your current financial advisor discussed the transfer of unused 529 assets to a Roth with you? If not, why not? At ClearPlan Wealth Management, we provide a holistic approach to financial planning by listening, offering guidance, and engaging valued resources to consider every aspect of your life and your desired legacy. Contact us today to start the conversation!

Investors should carefully consider the investment objectives, risks, charges, and expenses with 529 college savings plans before investing. The official statement is available through your financial advisor and should be read carefully before investing. Before investing, it is important to consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state. Neither Raymond James Financial Services nor Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional. Any opinions are those of ClearPlan Wealth Management and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of selected strategy. Like Traditional IRAs, contribution limits apply to ROTH IRAs. In addition, with a ROTH IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a ROTH IRA are never tax deductible, but if certain conditions are met, distributions will be completely tax-free. ROTH IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted.