529 Plan Beneficiaries Can Look Forward to This Perk in 2024

A 529 plan lets you kill two birds with one stone: You can save up for your child's college education costs while also earning a break on your taxes. But since there's a 10% penalty on top of income taxes for making non-educational withdrawals, some families have been hesitant to contribute to one. Fortunately, the decision to use these accounts is about to get easier.

A provision of the SECURE 2.0 Act, passed at the end of 2022, will go into effect in 2024, and it could be a game-changer for those with leftover funds in their 529 plans.

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Your extra savings can now work for you

Beginning next year, families will have the option to roll over unused 529 funds into a Roth IRA. But there are some rules you need to be aware of, including:

• There's a lifetime maximum rollover of $35,000.
• The 529 plan must be open for at least 15 years before you're allowed to do the rollover.
• You can only roll the money over into the beneficiary's Roth IRA.
• You cannot roll over more than the Roth IRA annual contribution limit ($6,500 in 2023) each year.
• You cannot roll over more than the beneficiary earned in income during the year.
• You can't roll over contributions or earnings made within the last five years.

Most of this is pretty straightforward, but there are a few things worth calling out. First, the IRS has yet to clarify what happens if you change your 529 beneficiary at some point. We don't know whether that would cause the 15-year clock to reset, or if you would be allowed to count the time since the account first opened. Hopefully, the government will issue more guidance on this soon.

Second, 529 plan to Roth IRA rollovers count toward the beneficiary's IRA contribution limit for the year. That means if a beneficiary rolls over the maximum amount for that year, they will not be able to make additional personal contributions to a Roth IRA or a traditional IRA until the following year. However, they can still save for retirement in other types of tax-advantaged accounts such as a 401(k) or health savings account.

Finally, unlike direct Roth IRA contributions, there are no income limitations for 529 plan to Roth IRA rollovers. This means it's an option even for high earners who wouldn't otherwise be able to make direct Roth IRA contributions.

How much could it help you?

For most people, $35,000 is already a lot of money. But it pales in comparison to what that money, properly invested, could grow into by the time the 529 beneficiary retires. Say you hope to transfer the maximum $35,000 to a Roth IRA beginning when the beneficiary is 18, and you roll over the current $6,500 maximum right away at the beginning of each year. Here's what your balance would look like over time:

Source: Author's calculations.

As you can see, the IRA balance grows pretty quickly from earnings as well as 529 rollovers. And this will continue as long as the beneficiary owns the account. If they earned the same 10% average annual rate of return from 23 until 65, the Roth IRA would be worth $2,780,189 without them contributing another dime of their own money. Even contributing modest amounts annually over the rest of their working life, it wouldn't be impossible for them to build up a portfolio worth $3 million or more that they could spend tax-free in retirement.

Of course, the biggest barrier to this for most people is just coming up with $35,000 in spare 529 plan funds to roll over in the first place. That's why some have been critical of this new rule, saying it only helps the wealthy.

But even if your beneficiary is only able to convert a small fraction of the $35,000 lifetime maximum, it can still go a long way toward increasing their retirement readiness. This might be the incentive you need to make 529 plan contributions if you're on the fence. Just be sure you understand all the rules so you don't run into problems when you try to initiate a 529 plan to Roth IRA rollover.