My 15-year old son told me he knew how to drive. “It’s not hard, Dad; I play Mario Kart all the time.” Fast forward and I have him behind the wheel in an empty parking lot sweating bullets.
“It’s fine,” I encourage him, “Just put it in gear. You said you knew how to drive.” Queue the five mph crawl across the parking lot and abrupt slamming of the brakes at the end.
Knowing that you can do something is a lot different than actually doing the thing. As a result of the SECURE 2.0 Act of 2022, 529 account owners know it’s possible to fund a Roth IRA account with 529 assets, but not necessarily how to do so.
What Are 529 Plans And Roth IRAs?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning you pay taxes on the money going into the account, but all future withdrawals, including earnings, are tax-free as long as certain conditions are met.
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Qualifications For Rollover
To convert a 529 savings account into a Roth IRA, certain conditions must be met:
- Contributions in the five years preceding rollover are ineligible.
- The 529 beneficiary must also be the Roth IRA account owner.
- The account owner must have earned income in the year of the rollover.
- The account owner must be under the annual income limit for Roth IRA contributions.
- The annual rollover limit is equal to the annual Roth IRA contribution limit.
- Direct contributions and rollover contributions are cumulative towards the annual limit.
- The account must have been open for at least 15 years prior to a Roth rollover request.
That 15-year requirement may cause headaches. Plans which have changed provider – such as when Fidelity took over the Connecticut Higher Education Trust 529 College Savings Program from TIAA in 2021 – may reflect the account opening date as the date of transfer rather than the actual account origination date. Be sure to have proof of record of the account opening date for your respective account, as many plans have changed administrator over the years, and you may be required to show proof of your account opening date in tax filings.
Note also that the beneficiary has a lifetime 529 to Roth IRA rollover limit of $35,000. Further, there is currently no option to make Roth IRA contributions for prior tax years, though this may change in the future.
What About 529 Prepaid Plans?
Federal law now allows account owners to roll assets from a 529 plan into a Roth IRA. However, each prepaid 529 plan has unique rules that may prevent rolling those leftover assets to a Roth IRA.
Florida Prepaid only ever allows for the return of principal, for example. As a result, distributions are never taxed but, then again, you didn’t make any money to tax in the first place. Private College 529 Plan, by contrast, allows accounts owners to request a distribution online for purposes of rolling over to a Roth IRA, it just needs to be marked on the request.
Every prepaid plan is unique, so you will want to contact your prepaid plan administrator for guidance on whether they allow rollovers.
States That Do Not Recognize Roth Rollovers As Qualified
It is important to note that not all states recognize Roth rollovers as qualified. As a result, the rollover may be subject to state income tax and/or tax benefit “clawbacks.” For example, you may owe tax on earnings in those accounts and – if you claimed a tax credit or deduction on 529 account contributions – the state may require repayment of those benefits. According to ISS Market Intelligence, only thirty states either explicitly conform to federal tax treatment of 529 rollovers to Roth IRAs or have no state income tax in the first place.
As an example, NY allows 529 to Roth rollovers. However, their January 24 supplement states, “Under New York statute, however, the New York Department of Taxation and Finance (DTF) has issued guidance that a New York Qualified Withdrawal does not include a rollover from an Account to a Roth IRA. Any such rollover will be considered a New York Nonqualified Withdrawal and will require the recapture of any New York State tax benefits that had accrued on contributions. Therefore, rollovers from a 529 plan account to a Roth IRA may result in adverse New York State tax consequences even if the rollover qualifies for favorable federal tax treatment. Account Owners in other states should seek guidance from the state in which they pay tax.”
Further, a number of states are still debating treatment of Roth rollovers. Due to the wide disparity in treatment, account owners should consult with a tax professional such as a CPA or Enrolled Agent to determine the tax implications of a Roth rollover regardless of state.
Logistics of Making the Distribution
Making the actual distribution from a 529 account to a Roth IRA is relatively straightforward, depending on the plan. To do so, the account owner must complete the required forms detailing the distribution request, as well as the receiving firms information. For example:
The NY Saves plan requires the completion of a relatively simple request form called the, “Direct Rollover Out to Roth IRA” form. Once this document is completed the account owner must send the form via U.S. Mail to one of the addresses listed on the form. Once received, it takes between three and five business days to process, after which the program will send a disbursem*nt directly to the custodial institution specified by the account owner (e.g. Charles Schwab, Fidelity, Merrill Lynch, etc.).
The U.Fund plan in Massachusetts, administered by Fidelity, uses the, “Withdrawals – 529 College Savings Plan” form to request a 529 to Roth rollover. Complete the form, indicate it’s a “529-to-Roth transfer,” and provide the requested information regarding the current and receiving accounts. Fidelity can accept the form via U.S. Mail or uploaded directly to its message center, which can help expedite the process. Once received, it takes one to three business days to process. If rolling the money from the 529 account to a Roth held at Fidelity, the transfer will complete the day the form is processed, otherwise it will be transferred via either EFT (direct to institution) or U.S. mail to the Roth IRA custodial institution.
The distribution may take several weeks to process, depending on the 529 provider and receiving financial institution. Each plan has its own unique process, so be sure to contact them in advance. Live support from 529 providers ranges from good to excellent, so don’t be afraid to pick up the phone.
Pitfalls to Avoid
There are several pitfalls to avoid when converting a 529 account into a Roth IRA:
- Account owners should be aware of the income limits for Roth IRA contributions and ensure that they are eligible to make the rollover.
- Account owners should be aware of the tax implications of the rollover, particularly if they live in a state that does not recognize Roth rollovers as qualified.
- Account owners should ensure that they have completed the necessary paperwork and provided the required information to avoid delays in the distribution.
Converting a 529 account into a Roth IRA can be a complex process, but with the right information and guidance, account owners can set appropriate expectations for processing time and successfully rollover the funds. It is important to understand the qualifications required, the tax implications of the rollover, and the logistics of making the distribution. Also note that tax laws and interpretations are in constant flux, so be sure to check for changes on an ongoing basis to federal and state laws.
