Turning College Savings into a Tax-Free Retirement Fund

By Jeffrey Meenes, CFP® (Published Date May 23, 2024)

When each of my children was born, I completed their 529 college fund applications, mailed them, and funded each with $1,000 before they even left the hospital. I've been diligently contributing monthly, ensuring enough savings to cover at least four years of tuition at a Massachusetts university.

However, scholarships and alternate educational paths could quickly leave their 529 plans overfunded. Until recent changes due to the 2021 Secure 2.0 Act, my future choices would be to transfer the excess to another family member's 529 plan or withdraw the funds, facing income taxes and a 10% penalty on the growth.

Fortunately, the 2021 SECURE 2.0 Act, effective January 1, 2024, offers another solution: rolling over unused 529 funds directly into a Roth IRA in the child's name. This provision allows for a head start on tax-free retirement savings. 

Here are essential restrictions to note:

• The 529 plan must be open for at least 15 years.
• Annual rollovers cannot exceed the Roth IRA contribution limit, currently $7,000.
• The lifetime rollover limit to a Roth IRA is $35,000, not indexed for inflation.
• Contributions and earnings from the last five years are ineligible for rollover.
• Once rolled into a Roth IRA, funds cannot be returned to the 529.

This benefit shifts the focus from tax-free education growth to tax-free retirement growth. Unlike a 529 plan's limited investment options, a Roth IRA offers diverse investment opportunities and various retirement goals. Starting retirement savings early secures tax-free gains and enhances financial security.

Roth IRAs also provide flexibility for emergency expenses without a 10% penalty, although taxes apply for withdrawals before age 59 ½. These expenses include first-time home purchases (up to $10,000), specific emergencies, birth or adoption costs, unreimbursed medical expenses while unemployed, disability, and death. Additionally, there are exceptions for domestic abuse survivors and qualified educational expenses.

When rolling funds out of a 529, you sell the current investments and purchase new ones in the Roth IRA. Under the new guidelines, these rollovers are tax—and penalty-free.

It's wise to start annual contributions of excess 529 funds promptly. Given that the $35,000 cap is not indexed, early rollovers maximize benefits from tax-free appreciation in the Roth IRA.

This content is developed from sources believed to provide accurate information from Meenes Wealth Partners. It may not be used to avoid any federal tax penalties. Please consult legal or tax professionals for specific information regarding your situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.