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Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Washington is representative of a common question on the new permitted Roth IRA rollovers from Section 529 plans.
“The client previously set up a 529 plan for his son. The son is an adult now and has finished school. Can the father change the beneficiary of the 529 plan to himself and roll over the surplus to his Roth IRA?””
If the father is the “account owner” (1) for the 529 plan on behalf of the beneficiary, and the plan agreement allows, the father can change the 529 beneficiary to himself as a qualified family member. And, while the SECURE Act 2.0 created the ability for a 529 beneficiary to roll over up to $35,000 from their 529 account established for at least 15 years to their Roth IRA during their lifetime, it is not presently clear whether a change in the 529’s beneficiary would trigger a new 15-year clock. If so, conservatively, the father would have to wait 15 years before being eligible to directly roll over the 529 assets to his Roth IRA.
As background, 529 education savings plans are accounts where taxpayers can make after-tax contributions that grow tax-deferred and can be withdrawn tax-free if the funds are used for qualified education expenses. While there are many benefits to these plans, one drawback has been that if an accumulated surplus existed, it could not be transferred out of the account without the beneficiary incurring taxes and a 10% penalty.
To help remedy this situation, the SECURE Act 2.0 included a provision that permits up to $35,000 of unused funds in a 529 plan to be transferred over to the beneficiary’s Roth IRA without incurring the 10% penalty or income taxes. There are a few requirements that apply to take advantage of this benefit:
The 529 account must have been in existence for a minimum of 15 years before directly rolling the funds into a Roth IRA.
The funds cannot revert to the owner of the 529 account, it can only be transferred to a Roth IRA held by the 529 beneficiary.
The transfer cannot consist of contributions that have been made in the past five years or earnings on those contributions.
Transfers must occur annually and cannot exceed the maximum contribution limits for a Roth IRA in the year of transfer, reduced by regular traditional IRA or Roth IRA contributions that have been made for the year.
The beneficiary must have earned income for the year at least equal to the amount transferred; and
The movement of assets must be completed in a direct trustee-to-trustee transfer.
The instructions to Form 5498 refer to the transaction as a “qualified rollover contribution” to the Roth IRA, and reportable in box 10 Roth IRA contributions. The IRS has added a new box 4b on Form 1099-Q to report a 529 transfer to a Roth IRA.
It is worth noting that a 529-to-Roth IRA transfer is permitted even if the individual would not otherwise be entitled to make a Roth IRA contribution because their Modified Adjusted Gross Income exceeds the applicable threshold.
Presently, it is not clear whether a change in a 529 beneficiary triggers a new 15-year clock in the case of a 529-to-Roth IRA transfer. We are still awaiting guidance from the IRS on this point. For now, the most conservative course of action is to execute a 529-to-Roth IRA transfer only where the 529 plan and beneficiary have been in place for at least 15 years. Further guidance may change that position.
(1) The individual who establishes and controls the 529 plan for the beneficiary.