Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / 529 Plans and the Roth IRA Rollover Strategy Explained
Transcript
- Lucas: Alright, let's talk about one of the biggest changes to 529 plans in recent years — the ability to roll unused funds into a Roth IRA. It's been around since 2024 under the Secure 2.0 Act, but I still meet people who have no idea it exists. Luna: Yeah, I think a lot of families worry about overfunding a 529 plan. The classic fear is you save too much, your kid gets a full ride, and then you're stuck paying a 10 percent penalty on the earnings. This rule basically solves that. Lucas: Exactly. So here's the headline: Starting in 2024, you can roll over unused 529 funds into a Roth IRA for the beneficiary. The lifetime limit is $35,000. That's not a small number — it's roughly seven years of max Roth contributions for a young person, if they have earned income. Luna: Wait, roll over — but does it count against the annual Roth IRA contribution limit? Lucas: Great question. Yes, it does. So the rollover is treated as a regular Roth contribution. That means for 2026, the annual limit is $7,000 — or $8,000 if you're 50 or older, but for a kid beneficiary, it's $7,000. So you could roll over up to $7,000 per year, as long as the beneficiary has at least that much in earned income. Luna: Okay, that's key. The beneficiary — your child — needs to have earned income from a job. So if your 18-year-old is a full-time student with no part-time job, you can't do the rollover that year. Lucas: Right. And the rollover can't exceed the beneficiary's actual earned income for that year. So if your kid earns $4,000 from a summer job, the maximum rollover is $4,000. You can't just put in the full $7,000. Luna: That makes sense. But there's also a rule about how long the 529 account has been open, right? Lucas: Yes, another important constraint. The 529 account must have been open for at least 15 years. And contributions made in the last five years are not eligible for rollover. So if you opened a 529 when your child was born, you're fine. But if you opened one when they were 10, you'd need to wait until they're 25 to start rolling. Luna: So this is really a strategy for families who start saving early. Let's say you're a grandparent who set up a 529 for your grandchild when they were born. By the time they're 18, the account has been open 18 years — well past the 15 year mark. Lucas: Exactly. And grandparents are a great use case. They often overfund because they don't know exactly how much college will cost. Now they have an exit ramp. The grandchild can use some of the money for college, and up to $35,000 of the remainder can go into a Roth IRA in their name. Luna: But what if the grandchild doesn't go to college at all? Or gets a full scholarship? Then the whole 529 is available for rollover, subject to the limits, right? Lucas: Yes. If the beneficiary doesn't attend college, the 529 can still be used for other qualified expenses — trade school, apprenticeship programs, even student loan payments up to $10,000. But if they just don't need it, the Roth rollover is a fantastic option. You avoid the 10 percent penalty on earnings, and the money grows tax-free in the Roth. Luna: So let's say you have $50,000 in a 529 that's been open 20 years. The beneficiary is 22, just graduated, and has a job earning $30,000. Can you roll over $7,000 this year, $7,000 next year, and so on, up to $35,000 total? Lucas: Exactly. It's a per-year limit, not a total annual cap on top of the Roth limit. So if they have enough earned income each year, you can roll over the maximum Roth contribution annually until you either hit the $35,000 lifetime limit or the 529 is empty. But remember, only the portion of the 529 that's been in the account for more than five years is eligible. So you might need to track that. Luna: That's a bit of administrative hassle. The 529 plan provider should be able to tell you which contributions are eligible, but parents need to keep good records. Lucas: Yeah, and the rollover must go directly from the 529 to the Roth IRA — you can't take a distribution and then deposit it yourself. That would trigger a taxable event. Also, the beneficiary must be the same person. So if you change the beneficiary to a sibling, the 15-year clock resets for that new beneficiary. Luna: Oh, that's a trap. So if you originally set up the account for your oldest child, and then you change the beneficiary to your youngest, the 15 years start from the date of the change? That could delay the rollover significantly. Lucas: Yes. But there's a nuance: the 15-year clock is based on the account's original opening date, not the beneficiary change date. Wait, let me double-check. Actually, the IRS guidance says the 15-year period is measured from the date the account was first established, regardless of beneficiary changes. But if you change beneficiaries, the five-year rule for contributions applies to the newest beneficiary's contributions. So it's a bit messy. Luna: So the safest approach is to keep the same beneficiary from the start. That way you avoid all the timing issues. Lucas: Absolutely. And for families who might have multiple kids, it's usually better to open separate 529 accounts for each child rather than one account and change beneficiaries later. That keeps each account's clock running independently. Luna: Now, what about the Roth IRA income limits? Normally, if you earn too much, you can't contribute directly to a Roth IRA. Does the rollover bypass that? Lucas: Great question. Yes, the rollover is not subject to the Roth IRA income limits. So even if the beneficiary — say your 25-year-old child — earns $200,000 a year, they can still receive the rollover. That's a huge advantage for high-earning young professionals who might otherwise be phased out of direct Roth contributions. Luna: That's a big deal. So a doctor or lawyer who finished residency with high income can still get that $35,000 into a Roth via a 529 rollover, even if they can't contribute directly. Lucas: Exactly. And the rollover counts as a contribution for that year, so they can't also contribute directly. But it's a nice way to supercharge their retirement savings early, especially since the money has already been growing tax-deferred in the 529. Luna: One more thing — what if the beneficiary doesn't have earned income? Maybe they're a full-time student for several years after high school. Can you just wait until they do? Lucas: Yes, you can wait. The 529 account stays open indefinitely, and the rollover can happen in any year the beneficiary has earned income. So you could wait until they graduate and get a job. Just be mindful of the 15-year rule — if you opened the account when they were 10, you have to wait until they're 25 anyway. But if you opened it at birth, you have plenty of time. Luna: So the bottom line: this is a powerful tool but it requires planning. You need to open the 529 early, keep the same beneficiary, and encourage your child to earn some income in the years after college. Lucas: Right. And it's worth noting that the $35,000 limit is per beneficiary. So if you have three kids, each could potentially get $35,000 rolled into their Roth IRA. That's $105,000 in total — not a bad way to pass on wealth tax-efficiently. Luna: And if our conversations about 529 plans and Roth rolls have helped you think about your own college savings strategy differently — well, we deliberately don't run ads on these episodes. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small way to keep these shows ad-free and focused on what actually matters for your family's finances. Appreciate anyone who chips in. Luna: Alright, back to the strategy. One thing I want to emphasize: this rollover is not a loophole. It's a deliberate policy change to encourage saving for college and retirement. But it's still subject to annual contribution limits, so you can't just dump $35,000 in one shot. Lucas: Right. And if you have more than $35,000 in unused 529 funds, you might need to use other strategies — like changing the beneficiary to a sibling, or taking a non-qualified withdrawal and paying the penalty on the earnings. But with the Roth rollover, you've got a great first option. Luna: One last practical tip: if you're planning to use this strategy, talk to your 529 plan provider. Some plans now have a streamlined form for Roth rollovers. Others might require you to initiate a distribution and then manually deposit it — but that's not allowed. Make sure they support direct rollovers. Lucas: That's a good call. The last thing you want is to trigger an unexpected tax bill because of improper paperwork. So do your homework. The Secure 2.0 rules are generous, but they're also precise. Luna: So, to wrap up: if you've got a 529 plan that's been open for 15 years and your child has some earned income, consider rolling up to $7,000 a year into their Roth IRA. It's a smart way to repurpose savings and give them a head start on retirement. Lucas: Exactly. And if you're just opening a 529 now, this is another reason to start early. The 15-year clock starts ticking from day one. Thanks for listening — we'll talk more next time.