SECURE 2.0 529-to-Roth IRA Rollovers

Below I’ll discuss the ins and outs of the new SECURE 2.0 529-to-Roth IRA rollover provision.  While an understanding of the details is great, the more important issue is this: does this new rule fundamentally change financial decision making and planning? 

UPDATE 1 March 1, 2024: There are now significant doubts as to the validity of SECURE 2.0, including the 529-to-Roth IRA rollover provision. See my YouTube video on a very important court decision that puts SECURE 2.0 on very shaky ground (though it is still the law of the land as of March 1, 2024).

UPDATE 2 March 1, 2024: As of now, the IRS and Treasury have not issued significant guidance on the 529-to-Roth IRA Rollover. Thus, many questions remain on how it works.

529-to-Roth IRA Rollover Introduction

SECURE 2.0 has a special rule (see Section 126 on page 2161), first effective in 2024, allowing a tax-free transfer of money inside a 529 to a Roth IRA. This provision has been met with some unbridled enthusiasm that, to my mind, should be scaled back.

Before we get started, it’s important to note that (i) this is a very new rule and (ii) at any time the IRS and Treasury could issue guidance concerning this new rule. For both those reasons, everything discussed in this post is subject to change. 

The above said, let’s discuss the parameters of this new rule, adding in the context of the already existing Section 529 rules.

First, consider the statutory definition of a 529. From Section 529(b)(1)(A)(ii): an account which is established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account. 

Second, we must consider Section 529(b)(6):

(6)Prohibition on excess contributions

A program shall not be treated as a qualified tuition program unless it provides adequate safeguards to prevent contributions on behalf of a designated beneficiary in excess of those necessary to provide for the qualified higher education expenses of the beneficiary.

To my mind, the combination of these two rules* and how the IRS views them in a new environment where money can go tax-free from a 529 to a Roth IRA tamps down on any affirmative planning to stuff 529s with a primary purpose of getting money into Roth IRAs. I would not be surprised to see the IRS and Treasury come out with regulations more explicitly prohibiting stuffing 529s in this way. 

*See also page 5 of the preamble of the never-finalized proposed 529 regulations stating that a 529 is “an account established exclusively for the purpose of meeting qualified higher education expenses of the designated beneficiary.”

What I believe is very much allowed is parents rounding up when funding a child’s 529. The above-cited Section 529 language should not be read to require parents to be conservative when funding 529s. Future higher education expenses are quite speculative. What will future college tuition be? Will the child go to grad school? Will the child graduate undergrad 3 years, 4 years, or 5 years? Will the child get scholarships? 

529-to-Roth IRA Rollover Details

First, the rule provides that, in any year, the beneficiary of the 529 can be given up to the annual maximum allowed Roth IRA contribution as a Roth IRA contribution from the 529. If done, the contribution from the 529 becomes the beneficiary’s annual Roth IRA contribution for the year. Thus, this new rule does not create additional Roth IRA limits for the beneficiary. 

One advantage is that the contribution is not subject to the Roth IRA MAGI limits. This advantage is not all that great, considering most young adult beneficiaries will not earn income exceeding the Roth IRA MAGI limits. Even if the beneficiary is very high income, he or she may be able to use the Backdoor Roth IRA to get around the MAGI limits. 

Second, in order to execute this maneuver, the 529 must be at least 15 years old, and the amount contributed is limited to the amount of contributions (and earnings attributable to those contributions) occurring at least 5 years prior to the transfer to the Roth IRA. The 5 year rule defeats the idea of “oh, my daughter’s a senior in college, let me contribute $30K to her near-empty-529 and now have runway to make 5 annual Roth IRA contributions for her for her first 5 years after college graduation.”

Third, the total that can be transferred to the beneficiary’s Roth IRA is $35,000. The $35,000 is not adjusted for inflation, significantly limiting the benefit of this new rule.

As a planning tool, this technique is quite limited because the technique does not create any new Roth IRA contribution limitation. The new rule does not, generally speaking, increase Roth IRA contribution limits. Further, parents thinking of supporting young adult children can simply gift their adult children their annual Roth IRA contribution out of Mom and Dad’s bank account. 

529 Rollovers as Roth Contributions and Roth Earnings

The new 529-to-Roth IRA maneuver preserves earnings in the 529 as “earnings” inside the Roth IRA. I refer to this as the “earnings-to-earnings rule.” This impacts how any future nonqualified withdrawals are made from the Roth IRA. From the now adult child’s perspective, a regular annual Roth IRA contribution is better than a 529-to-Roth rollover, because the 529-to-Roth rollover limits how much of the contribution is easily withdrawn as a return of prior contributions.

Here are two examples to illustrate the concept:

Example 1: Mark graduated college and started his first full time job in 2024. He contributes $6,500 to a Roth IRA for 2024. If Mark ever has an emergency, he can withdraw the $6,500 from the Roth IRA at any time for any reason tax and penalty free.

Example 2: Julile graduated from college and started her first full time job in 2024. Her father named her the beneficiary of a 529. Assuming the 15 year rule and the 5 year rule are satisfied, her father can direct $6,500* from the 529 to Julie’s Roth IRA for 2024. At the time of the transfer, the 529 consisted of $30,000, $15,000 of previous contributions and $15,000 of earnings. The $6,500 goes into the Roth IRA as $3,250 of contributions and $3,250 of earnings. Assuming Julie has made no other Roth IRA contributions, the most she can withdraw from the Roth IRA tax and penalty free for any reason prior to age 59 1/2 is $3,250. 

*Note the 2024 Roth IRA contribution limits have not been published as of this writing. This uses the 2023 contribution limit as the 2024 contribution limit for illustrative purposes only. 

The earnings-to-earnings rule makes sense to (somewhat) protect the 529 earnings rule. If 529 rollovers went into Roth IRAs entirely as contributions, the 529-to-Roth maneuver could be used to bail out 529 earnings by rolling to a Roth IRA and then immediately withdrawing, taking advantage of the Roth IRA nonqualified withdrawal rules to get the 529 earnings out tax free. 

The above said, the hope for most receiving the benefit of the 529-to-Roth IRA rollover is that they do not make withdrawals from their Roth IRA for many years, making the new earnings-to-earnings rule mostly academic.

Sean’s Take

So how do I view the 529-to-Roth IRA rollover? I view this as a helpful, though quite limited, bailout technique for overfunded 529s. As a bailout technique, it’s a nice tool to have in the toolbox. The people who should be happy about it are those parents/grandparents with either a student in college today and/or a recent graduate and an overfunded 529. 

The above said, the 529-to-Roth IRA is not a technique that provides much, if any, value from a planning perspective. I do not believe that this new maneuver significantly impacts financial planning for most parents, as I don’t believe it makes the 529 all that much more attractive. 

Compare (i) 529s and this provision with (ii) simply investing money in taxable mutual funds and then using that money to fund a child’s college education and giving them $35K to be invested in Roth IRAs as a young adult. Yes, the 529 plus the 529-to-Roth is better than using taxable accounts, but not by enough for me to get very excited. Remember, in the FI community, the primary goal is not to optimize your child’s tax situation. Rather, for most parents, the primary goals are to secure Mom & Dad’s financial independence and be sure that Junior never has to worry about Mom & Dad’s financial security during Junior’s adulthood. 

The availability of the 529-to-Roth rollover reduces concerns about overfunding a 529, but only modestly so. Even with this new rule, I believe two things are true. First, most young parents should focus on building up their own financial assets instead of funding 529s. The availability of this new rollover does not significantly change planning for young parents, in my opinion. 

Second, those parents with extra money in 529s after a child graduates college should still consider changing beneficiaries to younger children or grandchildren primarily, and use the new 529-to-Roth IRA bailout technique as an alternative if no other beneficiary needing tuition assistance is readily available. To my mind, if there’s a successor beneficiary readily available, changing the beneficiary will usually be the preferable option, as it can be done instantaneously without worrying about limits and holding periods, and there’s no need to coordinate with the Roth IRA’s financial institution. 

529 Seasoning

Some are discussing new parents opening a 529 at birth just to season the account so the account qualifies for the 529-to-Roth IRA maneuver sooner rather than later (before the child’s 16th birthday). As I believe young parents should be focused (financially) on securing their own financial future, I do not believe it should be a priority to do this. My (financial) hope for most young parents is that they first secure their own financial future during their child’s childhood. 

If the parents’ financial future is secured by the time the child is in high school, the parents can start 529 funding to grab some state tax deductions or credits (if applicable). In such cases, when the funding occurs closer in time to college, it should be much easier for the parents to “right size” the 529 such that it is not overfunded for college. In those cases, any small remaining 529 balance can be bailed out by changing the beneficiary or using the 529-to-Roth IRA maneuver, even if it does take a few more years to satisfy the 15 year rule.

In addition, what’s the rush? So what if you have to wait 10 years until after Junior graduates college to execute the 529-to-Roth IRA rollover? In those 10 years you get tax free growth, and even if Junior has become the CEO you can still execute the maneuver, since the annual contribution MAGI limit has been eliminated for those doing the 529-to-Roth IRA rollover.

The downside of foregoing several years of pre-graduation seasoning is that additional time could cause growth such that the total in the 529 exceeds $35K by the time the 15 year clock is satisfied. I’d argue a 529 established much closer to the beginning of college is less likely to be significantly overfunded, mitigating this downside concern.

Multiple Beneficiaries

I think multiple beneficiary planning for the 529-to-Roth IRA maneuver is going to be very challenging. Consider the following situation:

Example 3: Dad owns a 529 and Son, age 21 is the beneficiary. Dad has paid for Son’s first three years of college through the 529. Daughter, age 25, is already a college graduate and in the workforce. If Dad’s 529 is now worth $100,000, in theory Dad could do a partial rollout of $30,000 to a 529 naming the Daughter as beneficiary with an eye towards the 529-to-Roth IRA rollover for Daughter’s benefit. However, remember the 15 year rule. The new 529 could not seed Daughter’s Roth IRA until Daughter is age 40. Further, if Daughter never uses any of the money for qualified educational expenses, the account is likely to run into issues being a valid 529.

529 plans cannot have multiple beneficiaries. This alone makes split-up planning for the 529-to-Roth IRA maneuver quite difficult. That said, if Daughter attended a year of graduate school at age 27 largely funded by this new 529, then Dad’s maneuver works, though remember that Daughter can only get the money into her own Roth IRA starting at age 40. 

Starting with Owner as Beneficiary

Some might consider a parent opening a 529 before the child is born naming the parent as both owner and beneficiary. After 15 years, the parent can make annual 529 to Roth IRA rollovers to their own Roth IRA. Once the $35K maximum has been hit, the parent could then change the beneficiary to a child. Considering the 529 statutory language discussed above, I don’t believe that is a wise course of action. Such a course risks 529 account disqualification unless the IRS and Treasury come out with rules affirmatively blessing it. Further, all that’s been saved is tax on interest, dividends, and capital gains of $35,000 of Roth IRA contributions. Under today’s investment friendly tax rules, that will not be very much tax. 

Don’t Plan on Using the 529-to-Roth IRA Maneuver if You Aren’t Going to College

The online world is full of scuttlebutt, and already I have seen social media posts inquiring as to whether adults should fund 529s for themselves with the idea of funding them today and starting 529-to-Roth IRAs rollovers 15 years later. I do not believe this is a wise course of action. 

Based on the language in Section 529 quoted above, I am highly skeptical of planning to put money into the 529 looking to get it into a Roth IRA. Sorry to all those 40-somethings out there thinking about throwing $20,000 into a 529 to fund their Roth IRA annual contributions in their 50s and 60s. 

Even if Congress were to change Section 529 tomorrow and explicitly allow 529 stuffing to get money into a Roth IRA, I don’t believe it makes much sense to affirmatively look to use a provision like this. It doesn’t increase the limit for Roth IRA contributions. If one is working 15 years from now, they will probably have the cash flow to fund their Roth IRA. Why do they need to invest through a 529 and get a very small tax break on the money for the 15+ years beforehand? Further, what if they aren’t working and don’t have compensation income in 15 years? 

Without compensation income (or spousal compensation income), one cannot make a Roth IRA contribution (whether from their bank account or from a 529). At that point the money might be trapped inside the 529, and withdrawable only if the owner is willing to pay ordinary income tax and the 10 percent penalty on distributions of earnings. 

Changing the Beneficiary to the Owner

Considering the language in Section 529 discussed above, I doubt the IRS will allow middle-age 529 owners whose schooling is far behind them to change the 529 beneficiary to themselves and then do the 529-to-Roth IRA maneuver. Yes, the IRS and Treasury may allow the successor beneficiary to step into the 15 year clock of the original beneficiary. But if the middle-age owner becomes the beneficiary, the 529 is no longer for the beneficiary to use for qualified educational expenses. At that point, it appears that there is a high risk the account may cease to be a good 529. If the owner then executes the rollover maneuver and their MAGI exceeds the annual Roth IRA contribution MAGI limit, they create an excess contribution to the Roth IRA.

It’s possible that the IRS will view this differently, but I would not count on it. Until the IRS and Treasury come out with more definitive guidance, I would expect that the benefit of this new rollover maneuver will largely be limited to those who completed their college education after the funding of a 529 for their benefit. 

Changing the Beneficiary and the 15 Year Clock

Does changing the beneficiary on a 529 reset the 15 year clock? 

My hope is that the IRS and Treasury allow a successor beneficiary to inherit the holding period the original beneficiary had. My view is that the IRS and Treasury are protected by the statutory language requiring 529s to be for the educational expenses of the beneficiary. If the successor beneficiary plans on using the 529 money only for their Roth IRA, the 529 can be disqualified. But if the successor beneficiary uses some of the money for education and then has leftover amounts, he or she should not need to wait until the passing of a new 15 year clock to get the money into a Roth IRA. 

If the IRS and Treasury are worried about abuses here, one possible compromise would be to allow the successor beneficiary to inherit the original beneficiary’s clock only if (i) the successor beneficiary is no more than ten years older than the original beneficiary and (ii) the successor beneficiary is a member of the original beneficiary’s family. 

A Critical Look at the 529

Conclusion

For those with an overfunded 529, the new 529-to-Roth IRA maneuver is very good news. That said, to my mind, it is just another tool in the tool box. In many cases, overfunded 529s are better used for another beneficiary, such as another child or a grandchild. But still, overfunded 529s are an issue, and it is good to have another bailout tool available, particularly if there is no successor beneficiary in the picture. 

I generally do not view the 529-to-Roth IRA maneuver to be a great planning tool. Generally speaking, it does not increase the amount that can go into a Roth IRA. That alone significantly diminishes its value from a planning perspective. Of course, everyone needs to do their own analysis and planning considering the particulars of their own situation. 

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