New change to 529 college savings plans has ‘so many caveats,’ advisor says. Here’s what to know

Starting in 2024, families can roll unused 529 plan funds to the account beneficiary's Roth individual retirement account, without triggering income taxes or penalties.
However, there are "so many caveats," according to certified financial planner and enrolled agent John Loyd, owner at The Wealth Planner.

The new year has ushered in a big change to 529 college savings plans, which has made the accounts more attractive to some investors. But the adjustment may have unexpected downsides, experts say.

Starting in 2024, families can roll unused 529 plan funds to the account beneficiary's Roth individual retirement account, without triggering income taxes or penalties, as long as the 529 plan has been open for at least 15 years.

Enacted via Secure 2.0, the change may offer more flexibility, but there are "so many caveats," said certified financial planner and enrolled agent John Loyd, owner at The Wealth Planner in Fort Worth, Texas.

The downsides of 529-to-Roth IRA rollovers

The biggest downside of a 529-to-Roth IRA rollover is the conversion counts toward your annual IRA contribution limit, which may stunt future growth across both accounts, according to Loyd.

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"You're reducing one and sliding it over to the other," he said. "If my kids are pulling money from their 529 to make Roth contributions down the road, Daddy's not going to be happy."

For 2024, the annual IRA contribution limit is $7,000, with an extra $1,000 for investors age 50 and older. There's a lifetime cap of $35,000 for 529-to-Roth IRA rollovers, which means it would take five years of $7,000 conversions to reach the limit.

Plus, you can't roll over the previous five years of 529 contributions and the beneficiary must have enough "earned income," or wages from a job, to match each year's conversion, similar to regular Roth IRA contributions, according to CFP Jim Guarino, managing director at Baker Newman Noyes in Woburn, Massachusetts. He is also a certified public accountant.

Generally, it's better to keep the money growing in a 529 plan and contribute to a Roth IRA separately because you can change 529 plan beneficiaries, Loyd said. "You always want to try to maximize those tax efficiencies," he added.

Wait until later in 2024 to 'test the waters'

If you're planning on a 529-to-Roth IRA conversion in 2024, Guarino suggests waiting until later in the year to "test the waters." The IRS and states may issue more guidance in the meantime, he said.

For example, it's unclear whether beneficiary changes restart the clock for the 15-year waiting period or whether states will mirror federal law and allow income tax and penalty-free rollovers.

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