FIRE Hack: 529 Plans Conversion to Roth IRA

Did you know you can convert the 529 College Savings account to a Roth IRA? This provision was part of the measure that was passed in December 2022. Woohoo! The ability to convert to a Roth IRA is fantastic. The Roth IRA is the gold standard of retirement savings accounts. It’s flexible and you don’t have to pay taxes on the gains. The ability to add more money to the Roth IRA is a great benefit for savers. There is no more excuse to avoid investing in the 529 plans.

We have been contributing to our son’s 529 since he was born in 2011. The main issue with the account is that we don’t know if our son will use it. He might get a scholarship, start his own business, or decide to attend community college first. What if we saved and invested and there is money left in his 529 after he finishes college? This is the reason most people give when they don’t use the 529 college saving plan. My previous answer was you can always change the beneficiary. We have 5 nieces and nephews. We could help them out if our son’s account has any money left. But the 529 is even more flexible now. If RB40Jr doesn’t use all the money in his 529, we can convert it to a Roth IRA! It will give him a head start on early retirement.

Oh, the main benefit of the 529 college savings plan is that you don’t have to pay taxes on the gains. And you may get a state tax deduction. The deduction depends on what state you live in. Check your state’s college savings website. The 529 college savings account is almost exactly like the Roth IRA. The big difference is that you need to use it for education expenses or else you’ll have to pay tax on the earnings and a 10% withdrawal penalty.

Here is the FIRE hack. You can take advantage of this new rule even if you don’t have a kid. You can open an account and name yourself as the beneficiary. If you don’t use the money for education, you can convert it to a Roth IRA later. There are some rules you need to follow, though.

529 Conversion Rules

  • The 529 plan must be open for 15 years. This is the reason I said young people will benefit the most from this new conversion allowance. We started saving for our son’s college education in 2011. He can start converting his 529 to a Roth IRA in just a few years. I’m pretty sure young workers can take advantage of this too. If they have an old 529 college savings account, they can add more money to it and then start the conversion in 5 years. All parents should open a 529 plan and put a few dollars in there to start the clock ASAP. ***Important*** If you change the beneficiary, the timer may reset. This isn’t clear at this point.
  • 5 years wait on new contributions. You can’t rollover the contribution or earnings on those contributions made in the last 5 years. I think this rule is fair.
  • $35,000 lifetime cap on conversion. Unfortunately, the lifetime cap is pretty low. Hopefully, they will increase it later.
  • Rollovers are subject to the annual Roth IRA limit. This is pretty low too. The annual Roth IRA limit is $6,500 for people under 50. This is fine for RB40Jr. He probably won’t make much income until he graduates from college. But for older folks, this rule is a bit confusing. Can you contribute $6,500 to your Roth IRA and convert another $6,500 from your 529 plan? Probably not. If you know the answer, let me know in the comment section. 
  • Rollover to beneficiary’s Roth IRA. This is another sticky rule. I’m the custodian of RB40Jr’s 529 plan. He is the beneficiary. I can’t rollover the 529 plan to my Roth IRA. It can only be rollover to the beneficiary’s Roth IRA account. It’s fine though. He needs a head start on his Roth IRA.
  • Rollovers can start in 2024.

Hmmm… These rules are annoying, but any tax savings is a win in my book. The biggest limitation here is the lifetime cap. $35,000 isn’t that much. I think it’s best to start converting the annual limit ASAP. That way the investment in the Roth IRA will have plenty of time to compound.

*Important* The Roth IRA and other qualified retirement plans are not counted as assets on the Free Application for Federal Student Aid (FAFSA). The 529 is counted as the parent asset on the FAFSA form. This new conversion rule could help some students get financial aid if they play it right.

RB40Jr’s 529 plan

You can see more details about RB40Jr’s college savings in this post – Why we’re using the 529 plan to save for college. I’ll show you a quick summary here.

So far, we have contributed $67,785 to his 529 college savings account. His account is now worth $112,458. It gained 66%. I guess that’s not bad. It looked way better at the end of 2021, though.

Anyway, our target for college savings is around $200,000 by the time RB40Jr starts college in 2029. I think we’ll get pretty close to the target. It depends on how the stock market performs over the next 6 years. 2022 was rough and 2023 might not be much better.

What do you think about this new 529 to Roth IRA rollover allowance? I think it’s a great way for young people to get a head start on their early retirement.

*Passive income is the key to early retirement. These days, I’m investing in commercial properties with CrowdStreet. They have many projects across the United States. It’s been working so well that I’m planning to sell our rental condo so I can invest more. Go check them out!

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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23 thoughts on “FIRE Hack: 529 Plans Conversion to Roth IRA”

  1. Regarding the restriction of “5 years wait on new contributions. You can’t rollover the contribution or earnings on those contributions made in the last 5 years.”
    I understand I can stop contributing the last 5 years, but what about the EARNINGS the last 5 years. Do I pull out the invested funds and let them just sit there the last 5 years without earnings in order for them to be eligible transfer? Or does this mean that only earnings from contributions made in the past 5 years are not eligible? (wording is tricky).

    Reply
    • I think it’s the latter – only earnings from contributions made in the past 5 years are not eligible.
      Let’s keep an eye on this. I’m sure it’ll be more clear once the brokerage starts supporting it.

      Reply
  2. I wonder if there will be a clawback of state taxes that were not paid on this money (for states that give tax deductions for 529 contributions) when it’s rolled into a Roth. I also wonder if you can rollover to a Roth with $0 income, since the IRS’s webpage on Roth Contribution Limits says its max is e.g. $6500 (2023) or the earned income, whichever is less. I’ve got my fingers crossed that the 529/Roth isn’t subject to needing earned income. But the way it’s worded “subject to the Roth contribution limits” makes me think it’s also subject to needing earned income. I hope not though. Will need more guidance on this in 2024.

    Reply
    • You’re right. There are some questions around earned income.
      I know the clawback depends on what state you live in. I rolled over the OR 529 to Vanguard in 2015 and we didn’t have to pay any clawback. Each state is different.

      Reply
  3. I didn’t know you could change the beneficiary, thats fantastic. We started one for our daughter in 2011, and have been contributing consistently since then. My concern is she will have too much money in there when she goes to college. Especially if she gets a scholarship. If we can roll that into an IRA, that is a game changer! Thanks Joe

    Reply
    • From what I’ve read, scholarships are not such a big deal because you can still pull the money out without the 10% withdrawal penalty. Here’s a good resource,
      https://www.savingforcollege.com/article/the-truth-about-scholarships-and-529-plans
      which says in a memorable way “the scholarships have turned your tax-free 529 investment into a tax-deferred 529 investment.”

      Yes, you have to pay tax on the gains if you take the money out in lieu of scholarships so the Roth IRA is more tax advantaged than the withdrawal. A 529 is still better than having the money in a taxable investment account for those 10-20 years.

      Reply
  4. 529 rollover to Roth IRA subject to annual Roth contribution limit, got it.
    But can you do the rollover for RB40Jr (a year later =15 year rule) even if he has no income/earnings himself?

    thanks

    Reply
  5. Also want to make sure that the 15-year conversion rule is counts from the opening of the account, right? not from changing the beneficiary?
    e.g. the account was opened over 20 years ago for my daughter but last year changed the beneficiary to her child. do we have to wait another 15 years to convert to the child’s Roth IRA?

    thanks

    Reply
  6. RB40:
    why couldn’t you change your beneficiary from son to yourself as beneficiary and then roll over to your Roth? see this:
    https://www.collegesavings.org/common-529-questions/#:~:text=Generally%2C%20anyone%20can%20be%20named,yourself%20as%20the%20named%20beneficiary.

    Q. Who can be a beneficiary?
    A. Generally, anyone can be named the beneficiary of a 529 account regardless of their relationship to the person who establishes the account. You can even establish an account with yourself as the named beneficiary.

    Reply
  7. Wow, this is a game changer! We’ve been wondering what we’re going to do if DC1 ends up at our state flagship instead of a fancy private college. 35K isn’t a lot, but as you say, if it increases that will be great. (And 6.5K/year… not a huge amount, but also not nothing.)

    I wonder if I should start contributing to DC2’s 529 again… I guess we will know more about DC1’s projected college expenses in a few months.

    Reply
    • I think it might be good to rollover to the Roth IRA as soon as I can. Since retirement assets don’t count toward FAFSA. But our net worth is probably too high for that already. Oh well..

      Reply
  8. The idea is very eye-catching.
    But all the rules make it far less appealing.

    *BoycottTwitter
    *BoycottTesla

    Reply
  9. I’ve been reading about the provision and was excited to know that my daughter could roll over her 529 funds to a Roth if she ended up not needing it.

    But, I hadn’t thought of opening a 529 for yourself… that’s some creativity, Joe! I love it!

    Reply
  10. Thanks for covering this. I saw it and I thought, “Well if my kids don’t use their 529, I could probably use it.” I think it’s extremely unlikely they won’t use it. It’s very flexible in that it can be used for room and board. There are a lot of things that adults who FIRE might want to use it for (cooking school for example).

    You mentioned that “Rollover to beneficiary’s Roth IRA” is a sticky rule, but couldn’t you just make yourself the beneficiary if you wanted to use it for yourself? And if you can do that, could you take the $35,000 limit for yourself and then change the beneficiary to him so he could his $35,000? Add in MrsRB40 and maybe you could convert half of the projected $200,000 amount. That would be a good hack if you need it.

    Final thought, RB40jr could use it for his kids. That would be a lot of compounding though.

    Reply
  11. Thanks so much for writing this post. First that I’ve heard. It’s a nice option. $35K conversion limit is better than nothing. Is entire conversion amount tax free since original 529 contributions are after tax?

    Reply

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