Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / 529 Plan Rollovers to Roth IRAs Explained
Transcript
- Lucas: So Luna, we've covered a lot of ground on 529 plans over the years — housing, travel, even weddings. But there's one big change that slipped under the radar for a lot of families, and it might be the most powerful one yet. Luna: You're talking about the rollover to a Roth IRA, right? That provision from SECURE 2.0? Lucas: Exactly. Starting in 2024, families can move unused 529 funds into a Roth IRA for the beneficiary without any tax or penalty. Before this, if your kid didn't use all the money, you either changed the beneficiary to another family member or you took the money out and paid taxes plus a ten percent penalty on the earnings. Luna: And now you can just shift it into a retirement account. That's a game-changer for a lot of parents. Lucas: It really is. But there are some specific rules you need to know. The first is that the 529 plan has to be open for at least fifteen years. So you can't open one today and roll it over next year. Luna: Fifteen years — that means this only works if you started saving early. Like when your kid was born or even before. Lucas: Right. And the beneficiary — the student — has to have earned income in the year of the rollover. That's the same rule that applies to any Roth IRA contribution. The rollover amount can't exceed their earned income for the year. Luna: So if your kid makes five thousand dollars at a summer job, you can roll over up to five thousand. That makes sense. Lucas: Exactly. And there's an annual cap too. The rollover counts against the regular Roth IRA contribution limit, which for 2026 is seven thousand dollars. So if your child already contributes to a Roth IRA, that reduces how much they can roll over in a given year. Luna: And there's a lifetime cap as well, right? I remember it's thirty-five thousand dollars. Lucas: Right, thirty-five thousand dollars total per beneficiary. So if your kid has forty thousand left, you can only roll over thirty-five thousand. The rest has to stay in the 529 or be withdrawn — with the usual taxes and penalty on earnings. Luna: That's still a huge win. I mean, you're basically giving your kid a head start on retirement savings, tax-free. Lucas: And it's not just for undergrads. This works for any beneficiary, including for graduate school expenses. So if your kid goes to med school and has leftover, same rules apply. Luna: But what about the fifteen-year rule? Does that reset if you change the beneficiary? Lucas: Good question. The fifteen-year clock resets if you change the beneficiary. So if you started saving for your oldest and then switch to the younger sibling, the clock starts over from that change. That's a big detail that could trip people up. Luna: So you really need to keep the same beneficiary for the full fifteen years to qualify. Lucas: Or at least not change it within the last fifteen years before the rollover. Also, the rollover has to go to a Roth IRA in the beneficiary's name, not yours. So you can't roll it into your own Roth IRA. Luna: Right, it's for the student. Which makes sense. Lucas: One more thing — the 529 plan must be the same plan for those fifteen years. If you transfer between states or plans, the clock resets. So pick a good plan and stick with it. Luna: That's a good tip. I know a lot of people switch plans to chase better fees, but that could cost them this opportunity. Lucas: Yeah. And the rollover isn't automatic — you have to initiate it. Most plan providers have a form or process, but it's not something the IRS does for you. Luna: So it's an active decision. You have to plan ahead and make sure you meet all the criteria. Lucas: Exactly. And here's a scenario to make it concrete. Say you started a 529 for your daughter when she was born, put in ten thousand dollars, and it's grown to eighteen thousand by the time she finishes college. She has a five-thousand-dollar summer job. You can roll over five thousand dollars into her Roth IRA, tax-free, penalty-free. That's five thousand dollars she can invest for retirement, and it grows tax-free for decades. Luna: That's a fantastic example. And it's not just for the wealthy — even small amounts can make a big difference over time. Lucas: And with the power of compound growth, that five thousand could be worth a lot more by the time she retires. It's a great way to repurpose leftover savings. Luna: But what about families who are still paying off student loans? Is there any conflict there? Lucas: Not directly. You can still use 529 funds to repay up to ten thousand dollars of student loans per beneficiary, and now you have the Roth rollover option as an alternative. It's a matter of which makes more sense for your situation. Luna: So if your kid has loans with a high interest rate, paying those off might be better than rolling into a Roth. And if they're debt-free, the rollover is a no-brainer. Lucas: Right. It's about comparing the guaranteed return on loan payoff versus the long-term growth of a retirement account. Luna: And with interest rates these days, that's a real trade-off. Lucas: Definitely. Let's talk a bit about the mechanics. The rollover counts as a contribution to the Roth IRA, so it has to be made by the tax filing deadline for that year, usually April 15th. And you need to make sure the rollover doesn't exceed the annual contribution limit. Luna: So if your kid contributes two thousand dollars to their Roth, they can only roll over five thousand from the 529 in the same year. Lucas: Exactly. And the rollover is not tax-deductible, but it's not taxable either — it's a distribution from the 529 that is not subject to the ten percent penalty or income tax on earnings. Luna: That's the beauty of it. You're basically moving money from one tax-advantaged account to another. Lucas: And there's no impact on financial aid eligibility for the beneficiary because it's not counted as parent or student income. Luna: Good point. That's a concern for a lot of families. Lucas: One thing to keep in mind: the Roth IRA has to be in the beneficiary's name, and they have to have earned income. So if your child is still in school and doesn't have a job, you might have to wait until they start working. Luna: That's a common situation. But once they get that first summer job, you can start rolling over. Lucas: Right. And you can do it over multiple years, up to the thirty-five thousand dollar lifetime limit. So you don't have to do it all in one year. Luna: That gives families flexibility. You can spread it out as your kid's income allows. Lucas: And this is where a lot of people get tripped up — they think the rollover has to be done immediately after graduation. But you have until the beneficiary is thirty — no, actually there's no age limit for the rollover, but you need to be mindful of the fifteen-year rule. Luna: So as long as you meet the fifteen-year holding period and the income requirements, you can do it anytime. Lucas: Exactly. Now, before we wrap up, I want to mention something a little different. We've been talking about financial strategies, and if these conversations have helped you think about your own savings differently, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo. That's literally what funds making this many episodes possible. Luna: Yeah, it's a small group, but it keeps the show ad-free and going. We appreciate every bit of support. Lucas: Back to the rollover — one last tip. If you're thinking about this, start by checking with your 529 plan provider to understand their specific rollover process. Some plans may have their own forms or eligibility checks. Luna: And it's worth talking to a tax advisor to make sure you're handling it correctly, especially with the earned income requirement. Lucas: Definitely. But this is a powerful option that could turn leftover college savings into a retirement nest egg. It's a win-win for families who saved too much.