New Rules … Roll Idle Balance Into a Roth IRA

May 2024

You, a relative, or someone you’re close to may worry about the tax consequences of withdrawing leftover funds from a VA 529 account. Good news! New rules allow unused 529 balances to be rolled over into a Roth IRA…tax and penalty-free.

Background

529 savings plans are investment accounts intended to encourage educational savings. Contributions to 529 plans are “after-tax”…meaning there may be no initial tax benefit depending on your state of residence. The payoff is earnings on the account are free from state and federal taxes, plus remain untaxed when withdrawn and applied to qualified higher education expenses.

Note: Contributions to a Virginia 529 plan are state tax deductible up to a maximum of $4,000 per account per year. Annual contributions in excess of $4,000 may be carried forward as future deductions.

Typically, contributions are made by parents or other responsible party to fund the anticipated educational expenses of a future student. However, what happens to unused funds if the “student” chooses not to attend college, gets a scholarship, or the 529 account is otherwise not depleted? Under the old rules, withdrawing those funds for nonqualified education expenses triggered an income tax plus 10% federal tax penalty on the earnings portion of the withdrawals.

Staying with the idea that the 529 plan was initiated with a potential student in mind, under the new regulations funds not applied to qualified education expenses can be rolled over into a beneficiary (“student”)-owned Roth IRA…tax-free and penalty-free effective January 1, 2024. This delivers a great way to kick start the erstwhile student’s tax-favored retirement savings.

Limitations, Rules, & Cautions

Of course it comes as no surprise that there are conditions that must be met and maintained to qualify and remain eligible for the benefits of the revised 529 regulations. Here’s a summary.

Limitations:

• Eligible 529 accounts must have been in existence for at least 15 years to avoid penalties and taxes in a transfer of funds to a Roth IRA.
• Contributions or earnings on contributions made in the last five years may not be rolled over.
• Rollovers to a Roth IRA from a 529 plan are not restricted to the Roth IRA income limits that govern standard Roth IRA contributions. A beneficiary may exceed those limits in transferring unused 529 funds.

Rules:

• The student (beneficiary) of the 529 account must be the Roth IRA account owner.
• The rollover amount from a 529 plan to a Roth IRA is limited to the annual contribution limits as defined by the IRS. In tax year 2024, the limit is $7,000…$8,000 for beneficiaries age 50 and older. The beneficiary must have earned income at least equal to the amount transferred in any year.
• The IRS mandates a lifetime limit of $35,000 in rollovers to Roth IRAs. That maximum amount may not be transferred all at one time and must conform to the annual contribution limits in the immediately preceding bullet point.
• Rollovers from the 529 plan must go directly to the Roth IRA provider.

Cautions: As with any new or revised legislation, there may be items that become subject to different interpretation and final rulings by the IRS.

Takeaways

• Since there is no lifetime deadline to transfer funds, it may be worthwhile to wait for more IRS guidance. The 2024 Roth funding deadline is April 15, 2025, so time to determine best decision for your circumstances.
• Consult your tax advisor for additional guidance.

The above presentation is meant as an overview only. 
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