Sec 529 Plan to Roth Rollovers
Families and students who have found an alternative way to pay for their education, or simply didn’t pursue a higher education, have concerns about left over funds being trapped in IRC section 529 accounts unless they take a nonqualified withdrawal and assume a penalty. This led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education. The SECURE 2.0 Act eliminated this concern by providing families and students with the option to avoid the penalty, potentially resulting in families putting more into their 529 account.
SECURE 2.0 Act Section 126 amends the IRC to allow for tax and penalty free rollovers from 529 accounts to Roth IRAs, under certain conditions.
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Beneficiaries of 529 college savings accounts would be permitted to roll over up to $35,000 over the course of their lifetime from any 529 account in their name to their Roth IRA.
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The 529 account must have been open for more than 15 years.
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These rollovers are also subject to Roth IRA annual contribution limits.
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The aggregate amount contributed to the 529 account in the previous five years cannot be rolled over.
Effective Date: Distributions after December 31, 2023
Basis: When a conversion or rollover from a 529 plan to a Roth IRA occurs, the amount converted generally does not create a new basis in the Roth IRA in the same way that a regular contribution would. Instead, the conversion amount itself is considered part of the basis – specifically, the contributed portion of the conversion.
Example: Taxpayer meets all the conditions for a 529 plan rollover to Roth IRA and rolls $6,000 from the 529 plan into a Roth IRA ($4,000 basis and $2,000 earnings).
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The $4,000 that represents the basis from the 529 plan remains considered as such. This means it was already after-tax money. Therefore, if this amount is withdrawn early from the Roth IRA, it would not be subject to tax again, though it might still be subject to penalties if withdrawn before age 59½ or not meeting specific exceptions.
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The $2,000 earnings portion is not considered as a basis. It is subject to tax rules governing earnings in a Roth IRA. If earnings are withdrawn before the account is qualified (account is at least 5 years old and not before the account holder reaches 59½), they may be subject to both taxation and penalties.
Thus, one needs to focus on how the ordering rules apply to distributions. Withdrawals from Roth IRAs are treated as coming first from contributions (or basis), then from conversions, and finally from earnings. This ordering rule assists in potentially minimizing taxes and penalties on early distributions.
Rollover from a Coverdell Account to Sec 529 Account
See the guide "Coverdell Savings Accounts" for information.