An unexpected double tax break for 529-to-Roth rollovers

There’s a chance to do two 529-to-Roth rollovers this year – but only if the first one (for 2023) is done by April 15.

One of the most talked-about provisions of the SECURE 2.0 Act is the one allowing a limited amount of unused funds in 529 accounts to be rolled over to Roth individual retirement accounts. This change became effective for rollovers beginning in 2024. However, 2024 offers a chance to double up on the tax break, and do two 529-to-Roth rollovers this year – but only if the first one (for 2023) is done by April 15.

The rollover provision can help those who have built up excess funds in 529 college savings accounts that may not be used in the future. However, the break is limited to a lifetime maximum of $35,000, and that limit can’t be used up all in one year.

Further, 529-to-Roth rollovers are considered Roth IRA contributions. So the sum of those rollovers and any other IRA contributions (Roth or traditional) made by the 529 beneficiary for the same year can’t exceed the annual IRA contribution limit. For 2023, the limit is $6,500 ($7,500 if age 50 or over), and for 2024 it increases to $7,000 ($8,000 if 50 or over).

HOW TO DOUBLE UP THE TAX BREAK

Assuming a beneficiary qualifies to make both a 2023 and 2024 Roth IRA contribution (and no Roth or traditional IRA contribution was already made for either of these years), a full 529-to Roth-rollover can be done for both years. But this is only possible if the first one is completed by the 2023 tax return due date (April 15, 2024), which is the regular deadline for making a 2023 IRA contribution.

The actual law wasn’t clear on whether this doubling-up could be done, but the IRS has blessed the strategy with this statement from the 2023 instructions for Forms 1099-R and 5498: “A distribution made after December 31, 2023, and before April 15, 2024, that is rolled over to a Roth IRA by April 15, 2024, and designated for 2023 would be reported as a Roth IRA contribution for 2023.”

This ability to jump-start Roth rollovers of unused 529 funds can provide a generous Roth IRA boost for 2024. Just make sure that the custodian knows to report the rollover for 2023 (due by April 15, 2024) as a 2023 Roth IRA contribution.

To make this strategy more appealing, it appears the law allows the 529-to-Roth limits to be applied per beneficiary. So this “doubling up” opportunity can be multiplied if someone has unused funds in more than one 529 plan for several beneficiaries, such as children and grandchildren.

If both rollovers are done this year for a total of $13,500 ($6,500 for 2023 + $7,000 for 2024 = $13,500) and there are, for example, three beneficiaries with unused 529 funds, that triples the 2024 rollover opportunity to $40,500. At first, the $40,500 appears to exceed the lifetime $35,000 limit. But there is a separate lifetime limit for each beneficiary, so the total lifetime limit in this case is increased to $105,000 ($35,000 x 3 beneficiaries). This can help those with larger than expected multiple 529 plan balances whittle them down by maximizing 529-to-Roth rollovers.

The 529-to-Roth rollover is a nontaxable transaction, but it must be done as a direct trustee-to-trustee transfer, and the rollover must go to the 529 plan beneficiary’s Roth IRA.

To be eligible for the rollover, the following additional conditions apply:

The 529 must have been open for at least 15 years. No word yet from the IRS if this 15-year period restarts if the beneficiary is changed. Although the spirit of the law appears to be that a restart would not be required, it might be risky to proceed that way without IRS guidance.

The rollover cannot include any 529 funds (contributions or earnings on those funds) made in the last 5 years.

As mentioned above, annual rollovers are subject to the annual IRA contribution limit, but this also means that the 529 beneficiary must otherwise qualify to make an annual Roth IRA contribution by having compensation (W-2 earnings or self-employment income). For example, if the child has no earnings, then the rollover cannot be done. However, if the child’s earnings are too high, that is not a problem. Yes, Roth contributions are subject to high income limits, but those rules do not apply for the 529-to-Roth IRA rollover option. Higher earners can qualify for the rollover even if that income would have otherwise disqualified them from making a Roth IRA contribution. For this group, the 529-to-Roth rollover is like a back-door Roth.

ACT NOW!

Remember, to qualify for this unexpected 2024 “double-up” 529-to-Roth rollover opportunity, the first one must be completed by April 15 (no extensions to this deadline). And that deadline will get here before we know it.

[More: Game changer or not, SECURE 2.0 529 rollover rule turns advisor heads]

For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com.