In recent financial news, a significant change was introduced to allow for the conversion of unused funds in 529 plans to Roth IRAs. This development offers a new avenue to maximize educational savings and ensure that investments continue to work for you or your beneficiaries.

Understanding 529 plans

529 plans are tax-advantaged savings plans designed to encourage saving for future education costs. They are named after Section 529 of the Internal Revenue Code and come in two forms: prepaid tuition plans and education savings plans. These plans are popular with parents and grandparents who want to fund a child’s education.

What happens to unused 529 funds?

While taking advantage of 529 plans can be beneficial for funding a child’s education, there may be cases where funds in a 529 plan might not be needed. Here are a few scenarios that might leave 529 funds unused:

• Scholarships: The beneficiary receives a scholarship, reducing the need for the saved funds.

• Change in educational plans: The beneficiary decides not to pursue higher education.

• Excessive contributions: More money was saved than what was needed for education.

Previously, withdrawing these unused funds for non-qualified expenses would result in taxes and penalties. However, the new legislation provides much-needed flexibility in this area.

New legislation: Converting 529 plans to Roth IRAs

Here are some key points of the new legislation you’ll want to be aware of:

• Eligibility: The 529 plan must have been open for at least 15 years to be eligible for conversion to a Roth IRA.

• Lifetime limit: There is a lifetime limit of $35,000 that can be converted from a 529 plan to a Roth IRA.

• Annual contribution limits: The converted amount counts towards the annual Roth IRA contribution limit, which is $7,000 for individuals under 50 and $8,000 for those 50 and older (as of 2024).

Benefits of conversion

Here are some specific benefits to converting unused 529 funds to a Roth IRA:

• Tax advantages: Just like contributions to Roth IRAs, withdrawals in retirement are tax-free, provided the account has been open for at least five years and you are over 59½.

• Continued growth: This conversion allows the unused funds to continue growing tax-free, ensuring that the money saved for education still contributes to the beneficiary’s financial future.

• Flexibility: This approach gives families more flexibility and control over their savings.

Considerations before converting

Before you decide to convert unused 529 funds to a Roth IRA, keep these tips in mind:

• Plan ahead: Ensure the 529 plan has been open for at least 15 years to qualify for conversion.

• Contribution limits: Be mindful of the annual contribution limits to Roth IRAs. If necessary, plan the conversions over several years.

• Beneficiary changes: If the original beneficiary no longer needs the funds, consider changing the beneficiary to another family member who might benefit from a Roth IRA.

Summing it up

The ability to now convert unused 529 plan funds to a Roth IRA is a game-changer for many families. It ensures that the hard-earned savings intended for education can still provide significant financial benefits, even if a beneficiary’s plans for education change. As always, consult with a financial advisor to understand how this conversion fits into your overall financial strategy so you can make the most informed decisions.

Contact us

For more personalized advice and to explore how to make the most of your 529 plan, contact Kelling CPA at 763.757.5116. We specialize in tax planning and preparation, and we’re here to help you navigate these new opportunities.