When my mother graduated from college in 1994, the average cost for an in-state, four-year degree and required fees (excluding room and board), adjusted for inflation, was $5,119 annually.[1] As of 2023, that amount has grown to $17,709.[2] Though the rise in cost alone provides one reason the Section 529 Education Savings Plan has become so popular for young Hoosier families looking to invest in their children’s future, tax-free growth and payout and accompanying state-tax credits provide additional reasons why families are conducting planning through such investments. Similar to Section 529 Plans, Roth IRAs, retirement accounts that are comprised of post-tax contributions, are continuing to gain popularity due to their tax-free growth and payout. As parents and grandparents invest funds into Section 529 Plans, one question that arises is whether they can thereafter roll those Section 529 Plan funds into a Roth IRA for the beneficiary. The short answer to this question is possibly, but the actual answer depends on nuances in both federal law and the law of your State of residency.
The Secure Act and The Secure 2.0 Act
The Secure 2.0 Act was passed by Congress and signed into law by President Biden at the end of 2022 and was preceded by the original Secure Act which became effective January 1, 2020. Both the Secure Act and the Secure 2.0 Act are primarily designed to assist in saving for retirement and to further incentivize both employers and employees to contribute to qualified retirement plans. Though Section 529 Plans are not directly considered retirement plans, both Secure Acts recognized the secondary impact college savings have on one’s ability to contribute to qualified retirement plans in the future. For example, the Secure Act took the first step by permitting graduates, under certain circumstances, to funnel specified amounts of their 529 savings toward repayment of student loans. More important to this discussion, the Secure 2.0 Act officially permitted Section 529 Plan savings to be rolled over into a Roth IRA. While the rollover is an interesting concept, it carries strict guidelines that must be adhered to and, in certain states, including Indiana, it is preceded by roadblocks.
IRS Guidelines on Secure 2.0 Act
Prior to rolling over funds from a Section 529 Savings Plan to a Roth IRA, both the contributor and beneficiary should keep in mind multiple federal requirements, including but not limited to the following:
- The 529 beneficiary must be the owner of the Roth IRA.
- The 529 must have been open for a minimum of fifteen years.
- The amount to be rolled over from the 529 to the Roth IRA must have been contributed to the 529 at least five years prior to the rollover.
- Any single, yearly rollover from the 529 to the Roth IRA added with any other contribution to such Roth IRA may not exceed the yearly Roth IRA limit—currently $7,000 for individuals under fifty years old and $8,000 for individuals fifty years old or older.
- The rollover from the 529 must be a direct rollover to the Roth IRA, meaning the contribution must be sent directly from the 529 plan administrator to the Roth IRA account.
- The lifetime limit for such rollovers is $35,000.00 (likely per beneficiary).
Though the above requirements provide only a handful of those set forth in the new rule changes, they are some of the more important ones to consider. Further, the above requirements need further Congressional or IRS guidance to understand their true effect.
First, the language of the Secure 2.0 statute is ambiguous as to whether the lifetime rollover limit is applicable to the 529 beneficiary or the 529 account owner. If the lifetime limitation is applicable to the beneficiary, then the beneficiary could only receive $35,000 in rollover funds, no matter the account owner. However, if the limitation is applicable to the account owner, then various account owners of different 529 plans—for example parents and grandparents—could each rollover $35,000 from their 529 to the beneficiary. For example, if an individual had two 529 accounts they are a beneficiary of, one where the account owner is the individual’s mother and one where the account owner is the individual’s grandfather, then under the second interpretation, a total of $70,000 could be rolled over to the beneficiary’s Roth IRA, $35,000 from each 529 account. Though many may be hopeful the second option is applicable, most practitioners believe the lifetime limit is applicable to the 529 beneficiary, not the account owner. Assuming that is true, then no matter who seeks to rollover the funds or how many 529 accounts exist for the specific beneficiary, the beneficiary could only receive $35,000 in rollover funds over the beneficiary’s lifetime.
Another clarification needed is whether the fifteen-year requirement merely requires that the 529 account have been open for fifteen years prior to the rollover or whether the statute requires an individual to have been the specific beneficiary of the 529 account for the entire fifteen years prior to the rollover.
Given the numerous requirements and the clarification needed, it is vital that you speak to your legal counsel, financial advisor, or accountant prior to making such rollovers.
Indiana Pitfalls
Though federal law places various roadblocks in the way of rolling 529 funds over to a Roth IRA, doing so is not impossible. However, when such roadblocks are combined with recent Indiana guidance, the rollover becomes less attractive. Under federal guidelines, so long as one meets the requirements listed above and a few others, the IRS will neither consider the rollover for income tax purposes nor apply the general ten percent (10%) penalty for an unqualified withdrawal; however, the Indiana Department of Revenue (IDR) has taken a different approach. In an August 2024, publication, the IDR indicated that a rollover from a 529 to a Roth IRA is not considered to be a qualified withdrawal for previously acquired Indiana credit recapture purposes. Notably, Indiana provides an annual twenty percent (20%) tax credit, up to $1,500, for 529 contributions. Because the IDR has taken the position that a rollover from a 529 to a Roth IRA is not a qualified withdrawal, the IDR is also taking the position that the state tax credit previously acquired is subject to recapture by the IDR. In other words, if a parent were to contribute $7,500 in a single year to their child’s 529 and therefore obtain the full $1,500 state tax credit and if the parent were to later roll those funds over to that child’s Roth IRA, the IDR would have the ability to recapture the previously acquired state tax credit, thereby making the child’s parent repay the credit to Indiana. This recapture result remains the same whether or not the federal requirements listed above are met.
Conclusion
Though the Secure Act and the Secure 2.0 Act created flexibility with Section 529 Education Savings Plans, especially as it relates to rolling over certain 529 savings funds to Roth IRAs, Indiana’s position related to the recapture of state tax credits for such rollovers constricts that federal flexibility for Hoosiers. Notably, because the rollover is considered a qualified withdrawal for federal purposes, completing the rollover and having the state tax credit subject to recapture is likely a better option than making an unqualified federal withdrawal which would be subject to the same state credit recapture plus federal income tax and a ten percent (10%) federal penalty. However, the most tax-efficient option for Hoosiers is very likely to keep those leftover or unused 529 funds in place. By doing so, the current beneficiary of the plan would conceivably become the owner of the plan in the future and name the beneficiary’s future child as the beneficiary. Meanwhile, the 529 would continue to grow tax free and the beneficiary could potentially contribute more to his or her own Roth IRA without a 529 rollover. In other words, by leaving the funds in the 529 and permitting the current beneficiary to become the future owner and name the beneficiary’s own child as a beneficiary, the current beneficiary would have an existing financial nest egg for the beneficiary’s child’s future college savings and would also have the ability to contribute more to the beneficiary’s own retirement given the existing 529 funds for their children’s college savings. Therefore, Hoosiers contributing to their 529 Education Savings Plans should give significant consideration to whether they wish to be subjected to the IDR credit recapture when rolling those funds into a Roth IRA.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, accounting, or investment advice. Please contact SKO or your other tax, legal, or investment advisor prior to engaging in any transaction.
[1] National Center for Education Statistics.
[2] National Center for Education Statistics.
