529 rollover to a Roth IRA: How the Secure Act 2.0 changed the rules

The SECURE Act 2.0 went into effect this year, and it could make preparing for retirement a little bit easier. The broad-ranging law, passed in 2022, contains a number of provisions designed to help Americans reach their savings goals. Among them is the ability to roll over extra money from a 529 to a Roth IRA.

The change provides a compelling new option for college savers: The money left over in your education savings plan is now a potentially tax-free source of income for your later years.

However, there are restrictions on who can perform the conversion and how much you can roll over. Let's take a look at these accounts and what you need to know about the new law.

A 529 plan is a savings account that allows people to set aside money for higher education. Any money placed in the account must be used for qualifying educational expenses.

In the past, if you made a withdrawal and used the money for non-education-related expenses, you paid income tax as well as a 10% penalty on any investment earnings you pulled out. Under the old rules, if the beneficiary did not use the funds for qualifying education costs, the only way to avoid the withdrawal penalty was to transfer the money to another beneficiary within the family, such as another child or even a parent, who could use it for their education expenses.

A Roth individual retirement account (IRA) is a tax-advantaged account designed for retirement savings. Unlike traditional IRAs, you contribute money you’ve already paid taxes on to a Roth IRA. The money in your Roth IRA grows on a tax-deferred basis, which means your balance isn't reduced every year by taxes on investment gains.

You can withdraw your original contributions to a Roth IRA tax-free and penalty-free at any time. And, when you reach age 59½, you can withdraw your earnings tax-free as long as you've owned the Roth IRA for at least five years. This feature makes these accounts particularly beneficial if you're young and pay a relatively low tax rate—later, you can make tax-free withdrawals at a stage in life when you expect to be in a higher tax bracket.

If you take money out of a Roth account before age 59½, you typically owe income tax plus a 10% penalty on the earnings portion of your withdrawal. However, one of the perks of a Roth IRA is there are several exceptions to the early withdrawal penalty that provide you with greater financial flexibility.

The SECURE Act 2.0 gives you the ability to transfer excess funds in your 529 to a Roth IRA without paying taxes or penalties. Below are the basic rules you should know about a 529-to-Roth IRA rollover.

Eligibility and criteria:

• The 529 plan must have been open for a minimum of 15 years.
• The owner of the Roth IRA must be the beneficiary of the 529 plan.
• The Roth IRA owner must have earned income at least equal to the amount of the rollover.
• Contributions made to the 529 plan in the last five years, including the associated earnings, are ineligible for a tax-free transfer.
• Transfers you make from a 529 to a Roth IRA count against your yearly Roth IRA contribution caps, which are currently at $7,000 for people younger than 50 ($8,000 if you’re 50 or older).
• The lifetime limit for rollovers is $35,000.

If you end up having money left over in a 529 plan after completing your education, rolling these tax-advantaged assets to a Roth IRA can help make it easier to reach your retirement goals in the long run. Because Roth accounts allow you to pull out tax-free money after reaching age 59½ and meeting the five-year rule, you're making a tax-smart move when it comes to retirement. Plus, it eliminates the income taxes and 10% penalty on the earnings that usually apply when 529 plan withdrawals aren't used for qualified education expenses.

Keep in mind that the SECURE Act 2.0 529 plan changes don't provide an incentive to a parent or grandparent to intentionally overfund a child's education account. The law only allows 529 beneficiaries to roll excess money into their own Roth IRA. Parents and grandparents can't put money into a 529 then turn around and transfer those dollars to their own retirement account.

Plus, any 529 funds that the beneficiary rolls over count against their annual Roth IRA contribution limit. So if your child or grandchild has earned income and your goal is to help them build retirement assets, making a gift directly to their IRA is likely a more advantageous approach.

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Creating a Roth IRA can make a big difference in your retirement savings. All future earnings are sheltered from taxes under current tax laws. If you meet a qualifying distribution event, the Roth IRA can provide truly tax-free growth potential.

See the difference

The new law gives families more options when it comes to their remaining 529 assets. Converting those dollars to a Roth IRA may or may not be your best choice depending on your situation. Here are some questions you may have if your education ended up costing less than you expected:

For most families, staying the course is still the best idea. The new rollover provision offers a sound option if you have leftover funds after attending a college, university or trade school. But it generally doesn't make sense to intentionally overfund a 529, even now. If you're a parent and anticipate that your child will have a significant amount of assets remaining after college, you may want to redirect future contributions toward other purposes—whether it's your retirement plan or another family member's 529.

A 529 plan always has been a great way to help save for education expenses while saving on taxes. The SECURE Act 2.0 gives you a little more flexibility if you happen to have money left over after you or your child receives an education. But to take advantage of the Roth IRA feature, you still have to meet all of the eligibility criteria mentioned above—including the requirement that the 529 plan be at least 15 years old at the time of the rollover.

If you're the beneficiary, you can now roll up to $7,000 per year (or $8,000 if over age 50) into a Roth IRA in your name. You can continue to do so until you reach the $35,000 lifetime limit.

It's one option to consider, but it's not your only option. You can choose to keep the money for future education needs or transfer it to an eligible family member's 529 account, for example. You also can withdraw the funds for noneducation expenses, though taxes and a 10% penalty will apply to the earnings portion.

The new law provides a way for you to save money in a 529 education plan without having to worry about incurring penalties or income tax in the event the money isn't used for education. Consider talking with a Thrivent financial advisor about how this provision and other important features of the SECURE Act 2.0 may affect your financial plan.