Your 529 College-Savings Plan Can Now Fund a Roth IRA

Roth IRA sponsors, including Fidelity Investments, Vanguard Group, and Charles Schwab, are ready for these rollovers and have posted forms for them on their websites. While the Internal Revenue Service still needs to clarify some issues, many 529 owners aren’t affected and can proceed.

Savers are hungry to know more. One is Aaron Benner, a 55-year-old tech consultant in Houston with a 529 account for each of his three sons. While two haven’t finished college, one has a scholarship. Benner foresees a total of about $20,000 of extra funds in the accounts.

He’s considering moving these funds into Roth IRAs for his sons. “It could be nice for them. There’s a lot of time to let the money grow, which is good because they won’t have pensions,” he says.

Here’s a rundown of what’s known—and unknown—about 529-to-Roth rollovers, plus alternative options for savers with extra funds in 529 plans.

The new Roth rollover option

First, it’s important to know that 529-to-Roth rollovers are meant to be a modest solution to a modest problem; they aren’t a boondoggle. In general, Congress has plugged potential loopholes.

As a result, these rollovers come with key limits. To be eligible, a 529 account must have been open at least 15 years, and rollovers cannot be contributions added in the last five years. In addition, the rolled-over funds must go directly from the 529 plan into a Roth IRA owned by the beneficiary.

In addition, 529-to-Roth IRA rollovers cannot exceed a total of $35,000 per beneficiary, although it’s unclear how this will be tracked. However, someone who owns several 529 accounts—say for different children or grandchildren—could have a $35,000 rollover limit for each one.

Rollover recipients also face other requirements that generally apply to Roth IRAs. Each recipient must have at least as much earned income as the rollover—so a beneficiary whose pay is $4,000 in a year could only qualify for a $4,000 rollover of 529 funds.

Normal contribution limits also apply. For 2024, total Roth contributions can’t exceed $7,000 per saver under age 50. So if a 529 owner rolls $5,000 of account funds into a Roth IRA for an eligible child under 50 this year, then the child can only put up to $2,000 more into a Roth IRA.

But here’s a welcome difference: The income limits for making Roth IRA contributions don’t apply to recipients of 529 rollovers. This will allow a broader range of savers to benefit, because normally they must have modified adjusted gross income below $146,000 (single filers) or $230,000 (joint filers) in order to make full contributions directly to Roth IRAs in 2024.

529 owners considering Roth rollovers should also check state law. Some states impose a tax on the rollovers if the dollars received a tax break going in, while others don’t. With federal taxes, contributions to 529 plans and Roth IRAs are both in after-tax dollars.

Switching the account beneficiary

A longstanding option for owners of overfunded 529s is to change the beneficiary to someone else who can use the funds for education expenses. Transfers are allowed to family members, broadly defined, and a wide variety of expenses are eligible—including K-12 private-school tuition in some states.

The new beneficiary could also be from a younger generation, like a grandchild. Although some of these transfers could be considered taxable gifts, the annual exclusion and the lifetime gift-tax exemption would protect many givers from having to write a check to Uncle Sam.

Under the new law, a key question about beneficiary changes hasn’t been answered: Do such transfers restart the 15-year clock for Roth IRA rollovers?

For example, say that Janet set up a 529 plan for her daughter Ellen 20 years ago. If Ellen doesn’t use all the funds, Janet can switch the beneficiary to her son Joe for his education expenses. But can she then do a 529-to-Roth IRA rollover in five years, when Joe is through school and funds are left in the account? Or would Janet have to wait another 10 years?

The law isn’t clear. Sarah Brenner, an attorney specializing in retirement tax planning with Ed Slott & Co., thinks it would make sense for the IRS to allow credit for the years the account was open for a prior beneficiary.

In that case, could 529 owners change the beneficiary to themselves and then roll over extra dollars to their own Roth IRAs?

These are issues for the IRS to decide, but the agency hasn’t yet released guidance.

Withdrawing excess 529 assets

Savers can also simply withdraw excess 529 assets, and the withdrawals will come in two pro-rata pieces consisting of contributions and earnings. The withdrawn contributions aren’t taxable—a fact that many savers overlook. But the earnings will incur income tax plus a 10% penalty, as they’re not being used for eligible education expenses.

If the student received a scholarship, however, then that amount could be eligible for a penalty-free withdrawal.

States may also penalize taxable withdrawals, especially if the saver got a tax break on contributions.

Write to Laura Saunders at Laura.Saunders@wsj.com