Overfunded 529 Plan? A Roth IRA May Be Your Best Solution

By Charles Thomas

Congress approved many financial changes in December 2022’s Secure Act 2.0. Many of these changes will not occur for several years because it takes time for the financial industry to adjust. However, as we digest these changes and how they impact our clients, we observe one change that can benefit many people today and in the future: the use of 529 plans.

The 529 plan is a college savings plan that grows tax-free from which you can withdraw money for school-related expenses. Unlike other school-related investment accounts, when the 529 plan beneficiary turns the age of majority—which in Florida is 21 years old—they do not gain full control of the account.

For 2024, the maximum contribution an individual can make is $18,000 (or $36,000 if married filing jointly) toward the beneficiary of the 529. An attractive feature is that multiple people—for example, parents and grandparents—can contribute the limit to a single 529 plan beneficiary. 

You can also contribute as much as $180,000 in one year, forwarding five years’ worth of contributions at once. Five years of having that money work for your beneficiary could make a significant impact. However, after a particular donor uses this five-year rule, they cannot contribute to the plan until after the fifth year.

Despite the advantages, 529 plans have always had one drawback: What if your child does not go to college or does not use all the 529 plan money? Before Secure Act 2.0, the most common solution was to transfer the assets to another relative, allowing them to use the funds. Another option was to take the 10% penalty for withdrawing the funds for non-related college expenses and pay taxes on the gains.

The good news is that Secure 2.0 has taken the answer to what to do with the funds further than anyone expected. Now, with the remaining money inside 529 plans, you can transfer a lifetime of $35,000 into a Roth IRA for that beneficiary. This is huge! The money that has been growing tax-free for the child will continue growing tax-free for them—but inside a Roth IRA, where they have more accessibility to the funds.

There are a couple of requirements:

• The 529 must be open for at least 15 years before you can transfer to a Roth IRA.

• The Roth IRA owner must be the same as the 529 plan beneficiary.

• You can only transfer the maximum Roth contribution for the given year. This number typically increases every year; in 2024, the contribution is $7,000, and if over the age of 50, the contribution limit is $8,000. So, if the Roth contribution of $7,000 does not change, it will take five years to reach the maximum lifetime benefit of the rollover from a 529 to a Roth IRA.

This is the first significant change that has happened to 529 plans since they came out. Ideally, we would hope to see the lifetime $35,000 increase. But for now, it’s a great start to capitalize on letting your money grow tax-free and getting a head start for your child or grandchild.