529 to Roth IRA Rollovers
The average 529 account balance is $27,741, according to the College Savings Plans Network-- about the cost of a year of in-state public college. If that's the case, why did Congress bother creating a rule that allows excess 529 funds to be rolled tax- and penalty-free to Roth IRAs?
Here's another statistic: Less than half of families who save for college begin saving before their child turns 7. In fact, 32% start saving when their child is between 7-12 years old; 16% waited until their student was a teenager. (8% didn't know when they started.) That's unfortunate, because the earlier you start saving, the more time your money has to compound and grow. Saving earlier means your money does more work to fund college; saving later means you do more work.
This is especially the case in 529 plans, where asset allocations in target enrollment funds get pretty conservative very quickly-- much more so than the target date fund in your 401k at work. Vanguard's 2035 529 target enrollment fund for 529s-- the one for a 7-year-old-- is about 45% fixed income and only 55% stock funds. By comparison, Vanguard's 2035 retirement target date fund is less than 30% fixed income. And a 13-year-old's target enrollment fund is 2/3 fixed income and short-term reserves, with only 1/3 in stock funds. Delaying contributing to your child's 529 means either passing up investing in the years when you can be most aggressive, and likely earn the highest returns, or taking on additional risk closer to college which could result in loss of principal.
Delaying saving for college occurs for numerous reasons, many of which are financial. Parents of younger kids often have large daycare bills and other expenses for littles, or a reduction in income while one parent devotes more time to childcare. But another common reason for delaying is "I don't know if my kid is going to college or not." And that's where 529 to Roth IRA rollovers are a huge deal.
Here's the thing: now that you can roll up to $35,000 from a 529 to a Roth IRA, it doesn't matter what your baby's eventual path will be. Your 529 isn't just a college savings account; it's a launch fund. If your child doesn't end up on the path to college, you can start rolling funds over from the 529 to their Roth as soon as they start earning income. And Roth IRA contributions can be withdrawn tax- and penalty-free at any point (earnings-- the growth that comes from investing those contributions-- can't be withdrawn until the Roth IRA account owner is 59-1/2). Need money for a car? A down payment on a house? Any of those can come from Roth IRA contributions.
There are a few requirements for 529 to Roth IRA rollovers:
The 529 account must have been open for at least 15 years before it's rollover-eligible
The lifetime maximum rollover per beneficiary is $35,000
Rollovers are subject to the annual contribution limit, currently the lesser of $7,000 or actual earned income for anyone under 50. That means that rolling over $35,000 will take at least 5 years.
The Roth IRA must be in the 529 account beneficiary's name and the rollover must be made as a direct rollover (trustee-to-trustee) from the 529 plan to the Roth IRA.
Contributions made in the last 5 years and earnings on those contributions are not eligible for rollover.
Of course, 529s can be used for a variety of purposes besides just college: trade schools and apprenticeship programs, graduate school, community college, even some certification programs. Account owners can also change the beneficiary to another family member, or simply take nonqualified withdrawals in which growth in the account is subject to income tax and a 10% penalty.
The key point is, don't delay opening a 529 just because you're not sure your baby is college-bound. And even if you're not able to contribute to it, use the account's gifting page to allow others who are generous with your kids to help build your savings balance. After all, it's not just a college savings account-- it's a launch fund!
And, if you're a parent of an older student who has excess 529 funds, you can begin the rollover process as long as the account has been open 15 years and the beneficiary (your student) has earned income. The beneficiary just needs to open a Roth IRA (or their parent needs to open a custodial Roth IRA for them if they're under 18); once that's done, simply reach out to your 529 plan to request the rollover. Act fast-- before April 15-- and you can make a rollover contribution for 2023 as well as 2024.
