How new rules let you roll unused 529 college savings into a retirement plan

Dear Liz: I have about $3,000 left in my daughter’s 529 college savings plan. My ex-wife has about $8,000 left. Our daughter has graduated and is not planning to get an advanced degree. It’s my understanding that new rules allow unused 529 money to be rolled into a Roth IRA in the child’s name, after taxes are paid upfront. Would this be a good move?

Answer: Possibly, and you won’t have to pay federal taxes on such rollovers, which will be available starting in 2024.

The Secure 2.0 Act, which passed into law late last year, created this new provision that allows the owner of a 529 account to transfer up to $35,000 in unused education funds to a Roth IRA for the account’s beneficiary, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

The 529 account must have been established for at least 15 years for a rollover to be possible. No contributions or earnings from the previous five years can be transferred to the Roth. Also, the $35,000 is a lifetime limit that can’t be transferred all at once — it’s subject to most of the annual Roth contribution rules. In 2023, for example, the maximum that can be contributed to a Roth IRA is $6,500 for people under 50 and $7,500 for people 50 and older, so it will take a few years of transfers to reach the $35,000 lifetime limit.

The IRS has yet to issue needed guidance, including how the law will affect beneficiaries like your daughter with two 529 plans. But you and your ex probably will have to coordinate these transfers to avoid exceeding the annual contribution limit. Also, if your daughter contributes her own money to an IRA or Roth IRA, that contribution would reduce the maximum that could be rolled over from a 529. If, for example, the limit is $6,500 and your daughter contributes $5,000, you’d only be able to roll a maximum of $1,500 (assuming your daughter is under 50).

There’s also some question about whether the beneficiary needs to have earned income equal to the amount contributed each year, Luscombe said. On the other hand, someone with a high income won’t be prevented from receiving these rollovers into their Roth IRA, he says. Normally, contributions to Roth IRAs have income limits, so this could be good news for higher-earning beneficiaries.

Plus, states may have to issue guidance about whether the 529 rollover to a Roth IRA is a qualified distribution for state income tax purposes, Luscombe said. If not, you might owe state taxes on the rollover even if no federal taxes are owed.

You have a few other options for unused 529 money. For example, you could change the beneficiary to a “qualified family member,” which could include yourself as well as the beneficiary’s spouse, child or other descendant, a sibling, stepsibling, in-law, aunt or uncle or their spouse, niece or nephew or their spouse, parents or other ancestors or a first cousin or the cousin’s spouse. Withdrawals would continue to be tax-free if used for qualified education expenses.

You also could withdraw up to $10,000 to pay student loans for the beneficiary or their sibling.

Or you could simply withdraw the money and use it however you want. You would pay income taxes and a 10% federal penalty, plus any state penalty, on the earnings. Some states offer a tax break on contributions, so you’d also want to check if there are tax implications for such withdrawals.

For many account owners, though, the Roth rollover option will be a good, tax-advantaged solution to help their beneficiaries jump-start or enhance retirement savings.

How to plan retirement withdrawals

Dear Liz: I am 65 and plan on working until 70 to get the maximum Social Security. I have a 401(k) worth about $290,000. How do I determine the maximum monthly payout I should take while being somewhat certain it will last until I’m 90? Our family has a history of longevity, typically living into the early 90s.

Answer: You may have heard of the “4% rule,” a guideline that suggests an initial withdrawal rate of 4%, with the amount adjusted each year afterward by the inflation rate. The rule stems from research by certified financial planner Bill Bengen, who in a 1994 research paper used historic market returns for a portfolio consisting of 50% stocks and 50% bonds to determine the maximum safe withdrawal rate for a 30-year retirement.

Some researchers believe a sustainable withdrawal rate should start closer to 3%, and others suggest higher rates if the account owner is willing to cut back spending in bad years.

However, most retirement accounts, including 401(k)s, are subject to required minimum distributions. These will start after you turn 73. (For people born in 1960 or later, such distributions will be required starting at age 75.)

The exact amount you must withdraw depends on your account balance at the end of the previous year as well as your age and life expectancy. The percentages you must withdraw could be slightly less or considerably more than 4% of your original balance.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.