The 529 plan is a popular choice for many families seeking tax-efficient ways to save for college. These plans offer potential tax reductions on state income tax, and the interest grows tax-deferred. Most compellingly, if withdrawals are used for eligible educational expenses, they're tax-free. However, there's a catch: a 10% penalty applies to non-educational withdrawals, causing some individuals to hesitate about overfunding these accounts. Fortunately, a recent legislative change provides a promising option for those left with excess funds in their 529 plan, helping them avoid penalties while boosting retirement savings.

In late 2022, the SECURE Act 2.0 introduced a crucial update, significantly impacting both retirement accounts and 529 plans. One game-changing provision is the ability to convert unused 529 funds into a Roth IRA, effective this year. This development allows families to seamlessly shift leftover education savings into a retirement vehicle, providing a tax-savvy method to support future financial security. However, there are outlined stipulations. The 529 plan must have been open for at least 15 years before any rollover attempt. Contributions and associated interest made in the last five years are ineligible for this transfer.

Moreover, the Roth IRA must be opened in the name of the 529 plan beneficiary, with a lifetime transfer cap of $35,000. Annually, the transfer can be made up to the annual Roth IRA contribution limit, which is $7,000 in 2024 for individuals under 50, or the amount of the beneficiary's earnings, whichever is lower. Any direct Roth IRA contributions will reduce the amount that can be transferred from the 529 plan that year. Therefore, achieving the full $35,000 transfer may require spreading the conversions over several years.

If any funds over $35,000 remain after fulfilling educational expenses and full Roth IRA transfers, you have a few options: incur a withdrawal penalty or adjust the 529 plan beneficiary, allowing other family members to utilize these educational savings. Given this shift, there are still uncertainties needing clarification from the IRS, such as penalties for exceeding annual Roth limits or the implications of changing the 529 plan's beneficiary on the 15-year condition. Until such guidelines are articulated, families are advised to proceed cautiously with 529-to-Roth transfers, especially when contemplating beneficiary changes.

Meanwhile, leaving funds in the 529 account remains an option, or potentially making direct IRA contributions for the beneficiary, ensuring they stay within the annual contribution limits to avoid tax penalties.