The ability to roll funds penalty-free from a 529 plan into a Roth IRA was one of the most headline-grabbing aspects of the SECURE 2.0 Act, which passed at the end of 2022. Last spring, we wrote a blog about the SECURE 2.0 Act’s provision that allows 529 plan funds to be rolled over into a Roth IRA starting in 2024. Some key components of the new provision include:  

• There is a $35,000 lifetime limit per beneficiary, which may be indexed to inflation in future years. 
• The account must have existed for at least 15 years before transfers to a Roth IRA are allowed. 
• Any contributions or earnings from those contributions made in the previous five years cannot be transferred. 
• 529 plan funds can only be transferred to a Roth IRA that is in the name of the 529 plan’s beneficiary.  

529 plan sponsors are starting to allow these transfers, but there are still a lot of outstanding questions regarding the logistics. If you are thinking of making a transfer from a 529 plan to a Roth IRA, proceed with caution.  

There are some questions yet to be answered by the IRS. The 529 plan industry has stated that a letter was sent to the IRS in September 2023 requesting feedback on these questions. The Investment Company Institute (a trade group that represents 529 plan trustees) also sent a comment letter to the IRS asking for clarification in March 2023. 

The 15-Year Rule 

The 15-year rule for the 529 plan is a key component of a 529 plan owner’s ability to make a transfer to a Roth IRA. But there are some significant outstanding questions related to the 15-year rule.  

1. Does changing the account owner reset the 15-year clock?  
2. Does changing the beneficiary reset the 15-year clock?  
3. If an account has not been with the current trustee for 15 years but had a balance rolled over from another trustee, does the time the account was open at the other trustee count toward the 15-year clock?  
4. Does opening a closed 529 plan allow the time the account was previously open to be counted toward the 15-year clock? 

Currently, 529 plan trustees are making the account owner attest to the 15-year requirement. This will likely continue, but account owners will need the questions above clarified to calculate the age of their accounts.  

Transfers between Beneficiaries 

Many parents and grandparents maintain 529 plan accounts for more than one child or grandchild. 529 plans allow for transfers to be made between children, grandchildren and other relatives fairly easily if all the accounts are at one trustee and have one owner.  

If a 529 plan owner has transferred money between accounts or wants to transfer money in the future, how do these transfers affect the 15-year clock and/or the rule against transferring funds attributed to contributions made within the past five years?  

Income Eligibility and Maximum Transfers 

The Roth IRA owner’s earned income for the year needs to be greater than the amount the 529 plan account owner is transferring to the Roth IRA. This is fairly straightforward.  

The SECURE 2.0 Act did not say that the income guidelines that apply to normal Roth IRA contributions will apply to transfers from a 529 plan account. This is one of the perceived benefits of the new provision because it could allow high-income earners to use a 529 plan to make Roth contributions. 

Roth IRA Phase-out Based on Modified Adjusted Gross Income 

The amount that a 529 plan account owner can transfer to a Roth IRA is subject to the normal annual Roth IRA contribution limitation, which is $7,000 in 2024. For normal retirement plan contributions, Roth IRA owners 50 and older can make a $1,000 catch-up contribution. It’s not clear whether this also applies to transfers from a 529 plan account to a Roth IRA. The IRS may allow it because there is still the aggregate $35,000 lifetime maximum.  

529 plan account owners who are transferring funds to Roth IRAs need to coordinate with the beneficiary to ensure that the 2024 annual maximum limitation of $7,000 is not exceeded when adding up the beneficiary’s own contributions to their Roth IRAs. This coordination will avoid an excess contribution.  

State Tax Rules 

This is where it gets messy. The SECURE 2.0 Act is a federal law and does not apply to how states handle the taxation of 529 plan contributions and withdrawals for residents of their state. Each state can create its own guidelines. It is important to remember that state tax treatment of a rollover from a 529 plan into a Roth IRA is determined by the state where you file state income tax. 

If a 529 plan account owner has previously claimed a state tax credit or deduction for a contribution to a 529 plan, there may be tax consequences for processing a transfer to a Roth IRA. The taxpayer may have to add back the amount of the Roth IRA transfer (to the extent that it was previously used for a credit or deduction) as income on the state tax return in the year of the transfer.  

Some states, such as California and New York, are also not considering transfers from 529 plans to Roth IRAs qualified transfers. If you are a resident of a state that does not consider a transfer from a 529 plan directly to a Roth IRA a qualified expense, the transfer could be subject to income tax on earnings and possibly a penalty.  

For California taxpayers, a rollover from a 529 plan account to a Roth IRA will be treated as a nonqualified withdrawal and the earnings portion of the withdrawal will be subject to California state income tax, including an additional 2.5% California tax. 

A full list of states that consider a transfer from a 529 plan directly to a Roth IRA a qualified expense can be found on the Saving for College website.  

Doing a Rollover Today 

Before requesting a transfer from a 529 plan to a Roth IRA, the Roth IRA owner should call the trustee of the Roth IRA and ensure that the trustee will accept the transfer from the 529 plan trustee. The owner should also ask about the preferred process for handling the transfer to ensure it is not rejected.  

An account owner cannot take a withdrawal, make the contribution themself, and have it count as a qualified transfer. The transfer must be a trustee-to-trustee transfer. The 529 plan beneficiary must already have an established Roth IRA prior to requesting a transfer.  

At Milestone Financial Planning, we primarily use Utah’s sponsored 529 plan, my529®. The state has now started allowing for transfers from my529 plan accounts to Roth IRAs using the Utah my529® Roth IRA Rollover Request form.  

At the bottom of the form, the account owner must attest to four statements that essentially transfer the burden of determining eligibility onto the account owner, seemingly as an honor system. It’s unclear whether my529 has any internal controls to validate the requirements. The statements are as follows: 

1. “I understand that the IRS has not issued guidance on 529 plan to Roth IRA rollovers and that I or the Roth IRA beneficiary will be responsible for any taxes or penalties resulting from failure to comply with the IRS rules ultimately issued.” 
2. “I have had this 529 account for a minimum of 15 years.” 
3. “The amount of this rollover does not exceed the total amount contributed to the my529 account (and related earnings) before the 5-year period prior to the rollover.” 
4. “This rollover will not cause me to exceed the annual maximum limitation on Roth IRA contributions (currently $7,000 for 2024).” 

Closing Thoughts 

For those with excess balances in a 529 plan, the new rules offer significant benefits and introduce opportunities for tax-efficient, long-term savings strategies. 

However, there are still outstanding questions that the IRS needs to answer for full clarity on how 529 plan account owners can take advantage of this provision of the SECURE 2.0 Act. We’ll keep an eye out for future developments, but if you’re sure you qualify now, this new planning opportunity is now available.  

If you need advice on college financial planning or financial planning in general, please reach out to our team. You can also learn about our team here.