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529 College Savings Plan Roth Conversions: Two Birds, One Stone
First Rule: The 529 plan you are looking to convert needs to be opened for at least 15 years before any conversions can take place. In short, you need to plan far ahead and get a 529 account opened and funded to be able to convert any of those assets to a Roth IRA.
Second Rule: The owner of the Roth IRA and the beneficiary of the 529 plan need to be the same. This one seems obvious, but it’s worth noting that you can change the 529 plan beneficiary to a different member of your family without penalties or creating a taxable event. If this is something you end up doing, just make sure the names on the two accounts match before doing any conversions.
Third Rule: Funds that you wish to convert from the 529 plan to a Roth IRA account must be contributed and left in the 529 account for 5 years to be eligible for tax-free transfer into a Roth IRA. In short, don’t wait until the last minute to contribute to a 529 plan, the earlier the better.
Fourth Rule: Any rollovers from a 529 plan to a Roth IRA count against the beneficiaries Roth IRA contribution limits. As of 2023, that limit is $6,500/year. Put another way, you can only convert a maximum of $6,500 a year (as of 2023) into the Roth IRA. Another caveat is the beneficiary of the 529 Plan needs to have earned income greater or equal to the $6,500 contribution amount that same year. So, assuming you opened a 529 plan when the 529 beneficiary was born, they would need to have a job when they are 15-16 years old and earning at least $6,500 per year. Time to get working!
Fifth Rule: There is a lifetime 529 conversion limit per 529 beneficiary of $35,000 (as of 2023). To some that sounds like a low amount, but once you factor in the compounding of growth that can be achieved from a young age the $35,000 limit does not seem as small.
So, what does that leave us with? It leaves us with an opportunity to calculate the amounts of 529 contributions needed to fund a loved one’s education while also funding the first 5 years (approximately) of Roth contributions a loved one would have to make otherwise. What we’re doing in the most basic sense is funding Roth Contributions for your loved one for them using their college funds from the 529. This can be incredibly beneficial because the beneficiary of the 529 can then focus on freeing up their own cash flow to invest more into the employer retirement accounts, save for a new car, a new home, etc.
This planning can be a little complicated when you include the fact that market returns can fluctuate over time, general inflation, large increase in education expenses, and legislative tax changes made over time. This is where we come in. Contact our office and we can not only walk you through how this strategy works but create a plan for your and your loved one(s) and execute it.
The views are those of Robert Jeter, CFP®, CRPC, and Eric Johnston, CFP®, and should not be construed as specific investment advice. Investors cannot directly invest in indices. Past performance is not a guarantee of future results.
Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results.
You should consult your tax advisor for specific advice on your situation and whether the strategies above may make sense for you.
Investment Advisor Representative offering securities and advisory services offered through Cetera Advisors LLC, member FINRA/SIPC, a broker-dealer, and a Registered Investment Adviser. Cetera is under separate ownership from any other named entity.