529 to Roth IRA Rollovers: How to Convert Unused 529 Funds

Marie-Claire Hart is a senior attorney for the Sophisticated Planning Strategies team at Northwestern Mutual.

It’s no secret that college is expensive. Luckily there are many ways to save—including options that offer tax benefits. One of the most popular options is a 529 education savings plan.

However, tax-advantaged plans like a 529 do come with limitations. If you don’t use the money for the intended purpose (education), you may owe taxes and penalties when taking the funds out of the account. It was a common concern for parents—what if their child didn’t use all of the funds?

Now the good news: A new law allows you to transfer unused 529 funds into a Roth individual retirement account (IRA). There are limits to how much of your 529 funds you can rollover.

Here we’ll review how 529s work and what you need to know about rolling unused funds into a Roth IRA.

529 Plans and IRAs

Let’s start with a review of the financial tools. 529 plans and IRAs are both accounts that allow you to save money in a tax-advantaged way. The 529s are for education, and the IRAs are for retirement.

529 plans

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. This can include college or vocational schools and even advanced degrees like legal and medical degrees. Many states allow the money to go toward private K-12 schools, but most people use the funds for higher education.

The accounts get their name from Section 529 of the Internal Revenue Code, which authorizes them. Earnings in a 529 plan grow tax-deferred, and withdrawals are tax-free if used for qualified education expenses. Many states offer state income tax deductions or credits for contributions made to 529 accounts. With 529s there are two key roles:

• The custodian: This is the person who opens the 529 plan and controls the money in the account. Often, it makes sense for the custodian to be the child’s parent or grandparent. The custodian is sometimes called the account holder.
• The beneficiary: This is the person who’ll use the money in the 529 plan for tuition, fees, books, and room and board. Typically, the custodian names their child or grandchild as the beneficiary. While these are usually two different people, they don’t have to be; you could be the custodian and beneficiary of a 529 that you plan to use for yourself.

Roth IRAs

A Roth IRA is an account to save for retirement. Unlike retirement accounts through work, you’ll typically open a Roth IRA on your own. When you contribute to a Roth IRA, you use money that has already been taxed. The good news is that in most cases you’ll never be taxed on the money again.

The funds will grow tax-free. You can withdraw the money you put in, tax-free, at any point. Earnings are tax- and penalty-free as long as you’re 59½ or older and have had funds in any Roth IRA for at least five years. Roth IRAs can be a great option for people early in their career when they are often in a lower tax bracket. Funding a Roth account throughout your career can provide significant tax-free income in retirement.

Why should you convert a 529 Plan to a Roth IRA? 

Parents, grandparents and others contributing to a 529 savings plan prior to the new law had a nagging worry. They knew that money could “get stuck” in a 529 and be subject to taxes and penalties if the beneficiary didn’t use the money for school.

Now families have a new option to avoid the money getting stuck. If the beneficiary gets a significant scholarship or doesn’t go to school, the 529 money can still go to good use. Now money in the 529 can be transferred into a Roth IRA without getting hit by federal taxes and penalties.

Rules for 529 to Roth IRA rollovers 

As with any tax-advantaged account, there are rules you’ll need to follow.

Timing

• The 529 must have been open for at least 15 years before you can roll over the funds to a Roth IRA.
• You can convert only contributions that have been in the 529 for at least five years (plus any earning on those contributions).

Limits

In addition to rules about the timing of rollovers, there are limits to be aware of.

The beneficiary must have earned income equal to or greater than the amount rolled over into their Roth IRA. So if you want to transfer $5,000 in 2024, the beneficiary must have earned at least that much in income.

You cannot roll over more than the annual maximum IRA contribution limit for the year ($7,000 in 2024). This includes contributions the beneficiary makes to other IRAs or Roth IRAs. If the beneficiary contributed $2,000 to an IRA, only $5,000 could be rolled over from the 529. The lifetime 529 to Roth rollover maximum is $35,000 per beneficiary. It doesn’t adjust for inflation. Remember that annual contribution limits are significantly smaller. This means that it could take multiple years to transfer all the 529 plan assets to the Roth IRA.

You may have heard that a Roth IRA has income limits. If you earn more than $138,000 in a year ($218,000 if you’re married filing jointly), the maximum amount you can contribute each year starts to go down. If you earn $153,000 ($228,000 if you’re married filing jointly), the door closes, and you can’t contribute directly to a Roth IRA.

Luckily, the 529 conversion to Roth described in this article isn’t limited by the typical Roth IRA income limits. In other words, even if the beneficiary’s income is too high to contribute to a Roth IRA, the beneficiary can still do a 529 to Roth rollover. 

Additional rules

• Only the beneficiary of the 529 can do the rollover, not the owner.
• The beneficiary of the 529 plan must also be the owner of the Roth IRA.

The rollover must be a direct rollover, not one that involves a disbursement to the beneficiary.

It’s not yet clear whether all states with income taxes will treat these rollovers as tax-free. Keep an eye out for news regarding your state. But even if states impose a tax, it’s unlikely to be a major burden since the annual rollover amount is capped. The 529 to Roth strategy is likely to be a good route for unused education funds under $35,000.

What to do after converting a 529 Plan into a Roth IRA 

Once you’ve completed the rollover, your money starts working for you. Younger investors saving toward their retirement have compound growth on their side. To keep your momentum going, consider these steps:

1. Set up automatic monthly contributions. Have some money flow from your savings account to a Roth IRA each month.
2. Check with your HR Department’s benefits area to find out whether your employer offers retirement savings accounts. These could be employer-sponsored traditional 401(k) or 403(b) accounts. If so, see if you can afford to put money from each paycheck into them. Many companies also offer matching contributions up to a certain percentage of your income or a specific dollar amount.
3. Try to avoid using the IRA money until retirement. Withdrawals could hurt you in the long run because they can mean missing out on investment growth.

You don’t have to do all this alone. Your Northwestern Mutual financial advisor can help you set up a Roth IRA and show you how it works alongside your broader financial plan. Your advisor can help you build a plan that helps you identify blind spots and opportunities and leverages multiple financial options that work together to help you grow your wealth while also protecting it from common risks.