The fear of having money trapped in a 529 plan has been on the minds of investors for years. Although the definition of qualified education expenses has been expanded multiple times to provide flexibility on how those funds can be used, there is still the worry of what to do with a remaining balance.
SECURE Act 2.0 was passed as part of the Omnibus Spending bill at the end of 2022. The law, which applies to distributions after December 31, 2023, expanded the use of 529 plans once again to provide an option for rolling funds from a 529 plan to a Roth IRA for the beneficiary. This new option is a significant game changer for families. It is meant to minimize the fear of overfunding an account; instead, encouraging families to begin funding as early as possible to maximize growth potential.
Since the bill’s passing in December of 2022, there have been plenty of questions about the rules and implementation, leaving investors to “wait and see”. The IRS recently provided guidance on the process.
Considerations
To receive this beneficial treatment, the account must have been open for 15 years and any contributions made within the past five years (and earnings on those contributions) are ineligible to be moved into the Roth IRA.
Contribution limits apply each year as well as a lifetime rollover limit of $35,000.
Rollovers can only be made to a Roth IRA for the benefit of the beneficiary of the 529 plan.
Eligibility
Earned income is still a requirement for Roth IRA rollover eligibility. While there are plenty of beneficiaries who may have some earned income, the rollover contribution cannot exceed the income earned (compensation/wages and self-employment income) by the beneficiary during the tax year.
Although the earned income requirement applies for eligibility, the annual income limitation threshold does not. For example, even if the beneficiary’s income is over the annual limit to make a Roth IRA contribution, the beneficiary can still make a rollover from the 529 plan to the Roth IRA.
Aggregation
If the beneficiary made any IRA or other Roth IRA contributions, the rollover amount must be reduced by those contributions. Therefore, if the beneficiary contributed $1,000 to any IRA, the maximum amount available for rollover is $5,500 (Tax Year 2023).
When?
Rollover contributions can be made any time after December 31, 2023.
TIP – A rollover in early 2024 can be used to fund the 2023 Roth IRA contribution. Specifically, the instructions to 2023 Forms 1099-R and 5498 detail the timeline for executing a Roth contribution for tax year 2023. A distribution from a 529 plan made after December 31, 2023, and before April 15, 2024, that is rolled over to a Roth IRA by April 15, 2024, and designated for 2023, would be reported as a Roth IRA contribution for 2023.
How?
The 529 provider’s paperwork will be used to complete this process. Each plan will have it’s own form. One of Wisconsin’s 529 plans, Edvest, has added this specific form for the new process. A Roth IRA will need to be open to receive the funds.
On Form 5498, a rollover from a 529 plan is reported as a Roth IRA contribution, and not as an IRA to Roth IRA rollover. The amount is reported in Box 10 of Form 5498.
The rollover must be a plan-to-plan or trustee-to-trustee rollover. This means you cannot take a check from the 529 plan to deposit into the IRA.