When each of our kids were born, we started a 529 plan for them.
And while our kids are brilliant and beautiful, you never know if they’ll all go to college. And it’s a lot of money to have invested in an educational account if your kids won’t be using it.
Now, given that we have four kids and how expensive college is, it seems unlikely that the money will “go to waste.”
Fortunately, even if they don’t use it, you can now use the 529 plan funds to juice up a Roth IRA… for your kids.
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How the 529 to Roth IRA Conversion Works
Thanks to the SECURE Act 2.0, you can roll over unused 529 funds to a beneficiary’s Roth IRA without paying any taxes and with no penalties.
Prior to the SECURE Act 2.0, if you didn’t use all of a 529 plan’s funds, your only option (to avoid taxation and penalties) was to change the beneficiary. If you were to use those funds for nonqualified or noneducational expenses, you’d pay federal income taxes plus a potential 10% penalty.
But now you can roll over excess funds to a Roth IRA – this is a huge benefit!
Here are the other rules you need to know about this rollover:
- There is a lifetime limit of $35,000 per beneficiary
- The 529 plan must be open for at least 15 years (open one with the minimum now)
- The funds you rollover must be in the account for at least 5 years
You’re still subject to the same rules with a Roth IRA. Your rollover amount is considered a contribution and so you’re limited to the annual limit for that year (in 2025, the annual Roth IRA contribution limit is $7,000). It’ll take about five years to hit the limit, as the Roth IRA contribution limit goes up pretty much every year.
How To Maximize This Benefit
If you don’t have kids but want to take advantage, open an account now and set yourself as the beneficiary. You can always change this to anyone in your family without penalty (and family is quite flexible). You want to do this as soon as possible to start that 15 year timer.
If you have the funds to do so, contribute as much as you can to get any state deductions. Every little bit counts!
If you don’t have kids, you can start rolling over these funds into your Roth IRA after 15 years.
If you do, change the beneficiary and when they start making money, you can rollover from their 529 plan.
How is this any different than investing the money yourself outside of the 529 plan? Your 529 plan grows tax free and does not have contribution limits. The downside is it must be used for educational expenses, except for this new rollover provision. So now you get tax free money moved into a Roth IRA, where it will also grow tax free and can be withdrawn tax free.
Why Is This So Powerful?
529 plans are similar to Roth IRAs in that you contribute after tax dollars and it grows tax free.
You may also get state tax benefits for contributing to a 529 plan. For example in Maryland, we can deduct our contribution on up to $2,500 per beneficiary from our state income taxes. It’s a minor benefit but one I’ll take!
The advantage of this is that you now have an account that will grow for 18 years and be there to fully fund your child’s Roth IRA the moment they start earning income. In the past (and still today), once your child started earning income, you could give them money to contribute to a Roth IRA. Now the excess funds in a 529 can play that role plus it will have been growing for 15+ years.
The “hack” is that even if you don’t have kids, you can start a 529 plan and set yourself as a beneficiary. Then, when you have kids, you can change it to them. And if you don’t have kids or anyone in your family paying educational expenses, you can use it to fund your own Roth IRA up to the $35,000 lifetime cap. What you gain in doing this is that 15 year requirement has started counting.
Is This Worth The Effort?
For most 529 plan owners, the benefit of this is that you have $35,000 of wiggle room. If you save too much, or the investments perform too well (what a terrible thing!), you know $35,000 of those funds can be extracted into a Roth IRA.
It also means you may want to overcontribute if you can because in 15 years, you can help your kids with a Roth IRA once they start making money. This could give them a jump start on their retirement savings and it will have cost you much less.
A $1,000 investment that earns 7% a year over 15 years will be worth $2,759.
Then, once your kid starts making money, you can use that to fund a Roth IRA that they can keep until they need it in retirement. And it’ll be their Roth IRA, which means there are no required minimum withdrawals so they are in full control.
Can you think of any downside? (other than you can’t spend the money now)
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About Jim Wang
Jim Wang is a forty-something father of four who is a frequent contributor to Forbes and Vanguard’s Blog. He has also been fortunate to have appeared in the New York Times, Baltimore Sun, Entrepreneur, and Marketplace Money.
Jim has a B.S. in Computer Science and Economics from Carnegie Mellon University, an M.S. in Information Technology – Software Engineering from Carnegie Mellon University, as well as a Masters in Business Administration from Johns Hopkins University. His approach to personal finance is that of an engineer, breaking down complex subjects into bite-sized easily understood concepts that you can use in your daily life.
One of his favorite tools (here’s my treasure chest of tools, everything I use) is Empower Personal Dashboard, which enables him to manage his finances in just 15-minutes each month. They also offer financial planning, such as a Retirement Planning Tool that can tell you if you’re on track to retire when you want. It’s free.
Opinions expressed here are the author’s alone, not those of any bank or financial institution. This content has not been reviewed, approved or otherwise endorsed by any of these entities.
Source: 529 to Roth IRA Conversion: An Early Retirement Hack
