New rules allowing for 529 plan rollovers include significant restrictions

New rules are in effect for 2024 that allow beneficiaries of 529 plans to roll over unused funds to a Roth IRA. These changes are intended to ease concerns about the tax implications of withdrawing money that might remain in an education savings account when it is no longer needed to finance the beneficiary’s education. But limitations on the rollovers and the lack of IRS guidance on the issue mean the new rules may not be as helpful as they might first appear.

A 529 plan is a tax-advantaged savings plan sponsored by a state, state agency or education institution to encourage saving for future education costs. Until this year, any income earned on the funds in the account that were left in the plan after a beneficiary’s education expenses were paid were subject to income tax and a 10% penalty.

The SECURE 2.0 Act passed in 2022 changed the law so that, starting in 2024, beneficiaries could roll over up to $35,000 in a 529 account into a Roth IRA if certain conditions were met.

Limitations on IRA rollovers

The new rules on 529 plan rollovers include:

The 529 plan account must have existed for at least 15 years before funds can be rolled over to a Roth IRA.

• Rollovers may only be to the Roth IRA of the beneficiary of the 529 plan account, not its owner. In cases where a parent is making contributions to a plan for a child, the parent is usually the account owner.
• Rollovers can’t exceed the annual contribution limit for Roth IRAs, which is $7,000 for 2024 ($8,000 for 50 and over).
• The annual limit on rollovers is reduced by the amount of any other Roth IRA contributions made during the year. For example, if a taxpayer under age 50 contributed $5,000 to their Roth IRA for 2024, they can only roll over an additional $2,000 from their 529 plan.
• A maximum of $35,000 can be rolled over from the 529 plan to a Roth IRA during the beneficiary’s lifetime.
• Contributions to a 529 plan and any earnings during the five years prior to the Roth IRA rollover can’t be rolled over.
• Rollovers must be directly from the 529 plan to the Roth IRA.

Unfortunately, due to the lack of IRS guidance on 529 plan rollovers, there remain some questions as to how the rules will be applied by the agency. One commonly cited issue is that the rules are not clear on how the 15-year period the account must be in existence before rollovers are allowed will be measured when there is a change in beneficiary.

Are you a tax professional with additional questions about 529 plans and other tax benefits available to help with the costs of higher education? Check out our on-demand webinar: Helping Clients Plan for Higher Education. The webinar is free for premium members.