The 529-to-Roth Rollover: Transforming Education Savings into Tax-Free Retirement Wealth
The 529-to-Roth Rollover: Transforming Education Savings into Tax-Free Retirement Wealth
COACHING POINTS
- The Change: Effective 2024 (SECURE Act 2.0), beneficiaries of 529 plans can roll over up to $35,000 of unused funds into a Roth IRA. This eliminates the fear of “overfunding” a college account.
- The Rules: The 529 account must have been open for at least 15 years. You can only roll over funds (and earnings) that have been in the account for at least 5 years.
- The Strategy: This creates a powerful “Dynasty” opportunity. Parents can fund a 529 early, let it grow tax-free, and if the child gets scholarships or doesn’t need the money, it jumpstarts their retirement savings tax-free.
For decades, the biggest risk of the 529 plan was the “10% Penalty” on non-qualified withdrawals. If your child didn’t go to college or received a full scholarship, your money was trapped. The new rollover rule changes the 529 from a strictly educational vehicle into a stealth retirement account. It allows for the tax-free transfer of generational wealth. Source: IRS Publication 970 / SECURE Act 2.0 Section 126
Scenario: Your child graduates with $35,000 remaining in their 529 plan (Cost Basis $15k, Gains $20k).
- Option A (Old Way – Cash Out):
You withdraw the $35,000 for non-education use.
Tax: Income tax on $20k gains (e.g., 24% bracket) + 10% Penalty.
Total Cost: Approx $6,800 in taxes/penalties. - Option B (New Way – Roth Rollover):
You roll over the $35,000 to the child’s Roth IRA over several years.
Tax: $0.
Penalty: $0.
Result: The full $35,000 grows tax-free for the child’s retirement.
What-If Scenario: Jumpstarting Retirement at 22
Comparison: Starting with $0 vs. a $35k Rollover.
| Starting Balance (Age 22) | Value at Age 65 (7% Return) |
|---|---|
| $0 (Standard) | $0 (Depends on future savings) |
| $35,000 (529 Rollover) | $643,000 (Tax-Free) |
Visualizing the Tax Savings
| Exit Strategy | Taxes & Penalties Paid ($) |
|---|---|
| Non-Qualified Withdrawal | 6800 |
| Roth Rollover | 0 |
*The rollover option completely preserves the capital, avoiding the erosion of wealth caused by income taxes and the 10% penalty.
Rollover Limits Explained
| Limit Type | Amount ($) |
|---|---|
| Annual Limit (IRA Max) | 7000 |
| Lifetime Limit (Total) | 35000 |
*You cannot move the $35,000 all at once. It counts toward the annual Roth IRA contribution limit (e.g., $7,000), taking about 5 years to maximize.
Execution Protocol
The 529 account must have been open for 15 years. If you open a plan today for a newborn, the option unlocks when they are 15. Action: Open a 529 with a small deposit immediately to start the clock, even if you don’t fund it fully yet.
The beneficiary (child) must have “earned income” (wages) equal to the amount rolled over in that year, just like a regular Roth contribution. They cannot roll over $7,000 if they earned $0.
Do not withdraw the cash to your bank account. Request a Direct Rollover from the 529 custodian to the Roth IRA custodian. If the check is cut to you, it may be deemed a taxable distribution.
COACHING DIRECTIVE
- Do This: Keep your old 529 plans open even after graduation. If there is a balance left, let it season until it meets the 15-year requirement for a rollover.
- Avoid This: Changing the beneficiary to a younger sibling if it resets the 15-year clock. (IRS guidance is currently pending on whether a beneficiary change resets the clock, so proceed with caution).
Frequently Asked Questions
Does this trigger state taxes?
It depends. Many states conform to federal law, but some (like California) may still treat the rollover as a non-qualified withdrawal subject to state income tax and “clawback” of previous deductions. Check your state rules.
Can I contribute to my Roth IRA AND do a rollover?
No. The rollover counts towards the annual limit. If the limit is $7,000 and you roll over $7,000 from the 529, you cannot make any additional regular contributions that year.
What about the 5-year funding rule?
Funds (and earnings on those funds) must have been in the 529 account for at least 5 years before they can be rolled over. You cannot dump cash in today and roll it over tomorrow.