New 529-Plan Rollover Legislation: Read the Fine Print

Although the bill’s intentions are good, it’s confusing and lacks limitations that are likely forthcoming, says our columnist.

By John Gehri
John Gehri
John Gehri

It’s likely at some point as an advisor that you will have a client who saved more in a 529 savings plan than was needed for the qualified educational expenses of the beneficiary. For clients with other children who are likely to also have qualified educational expenses, one option is to change the beneficiary and allow the other child to use the additional assets. But what if the other children aren’t going to need the funds or what if the family has one child? What options can an advisor offer in these cases?

Under a new bill, funds could be rolled into a Roth IRA for the benefit of the same person. The College Savings Recovery Act was introduced by Richard Burr, R-N.C., and Bob Casey, D-Penn. The new bill was originally part of Burr’s more comprehensive 2017 Boost Savings for College Act, which never got to a full Senate vote.

At first glance this sounds like a great benefit to set a child up for a successful start toward saving for their retirement needs. But like any piece of tax legislation, the large print gives, and the small print takes away.

Confusing Qualifiers

First, Section (2)(a)(E)(i) of the new legislation says that funds not sent directly between custodians must be in the 529 plan for at least ten years prior to moving them to a Roth. This will be a hurdle for both the taxpayer and for the 529 provider. Since 529 plans were not designed to track contributions in this manner and providers typically only make seven years of statements available, it will be up to the client to document the correct amount. A combination of bank statements and 529 statements may be helpful to prove the correct amount.

Further, in Section (2)(a)(E)(ii) of the same legislation we see that this amount is the current year contribution and is limited to the lesser of the total remaining amount that the beneficiary is eligible to contribute, or the principal amount contributed to the 529 plan more than five years ago.  Well, this just got confusing so let’s keep going.

The ordering rules outlined in Internal Revenue Code Section 408A(c)(2)(B) of the bill tell us that the contribution amount allowed in a Roth is the lesser of earned income or the annual limit minus what was already contributed to a traditional IRA. In other words, the Roth contribution is made after all other contributions are complete and would be deemed the excess if too much was put in.

Numbers Add Clarity

So, let’s assume a 529 plan has a remaining balance of $50,000. Of that amount, $20,000 has been in the plan more than ten years and $15,000 of this is principal.  The client, age 43, is eligible to contribute the full $6,000 amount to a Roth IRA in the current year but has already contributed $1,000 year-to-date.

In this example, the client could only rollover $5,000 to the Roth from the 529. Furthermore, any rollovers would most likely be limited to one per year, as this is the current rule for indirect retirement plan rollovers. The client would have to remember they already contributed $1,000 so they wouldn’t mistakenly make an excess contribution.

The bottom line on moving funds: Process the transaction directly between custodians to make it easier.

Thankfully, for funds sent directly between custodians, S4400(2)(b) of the legislation tells us that amounts properly moved will be treated as a qualified rollover under 408A(e). In other words, the amount that can be rolled over would be unlimited. Annual contribution limits apply if the parent takes a distribution that is not a rollover and then wants to roll it into the Roth.

For example, if John has $20,000 in a 529 for Ryan and John distributes the full $20,000 to a checking account, at most $6,000 of the total could then be moved into a Roth. However, if John had the 529 custodian directly rollover the money to a Roth without receiving it first, the full $20,000 can be moved.

The tax treatment into the Roth would be the same as if a Roth IRA or Roth 401(k) funds had been distributed and then moved into the receiving account. These deposits would appear on Form 5498 issued by the Roth custodian.

Moving the funds in this manner would also allow for more than one rollover per year into the Roth.  This section of the code does not have a dollar limit and will allow the best tax benefit.

Looking Ahead

Sounds great! Now all my clients can establish Roth IRAs for their children without the income limitations of Roth contributions, right? Not so fast. Although the drafters of the bill haven’t inserted anything to limit the potential to abuse this option, a final version will certainly have a few limitations.

While this bill is a good start, there are some changes that could give it a wider appeal. Let’s start with the most pressing problem: Your clients, the parents that funded the 529, haven’t been saving enough for their own retirement.

It’s noble to give them the option to provide a head start for the future retirement of their children. But allowing these funds to go to the parents’ Roth IRA would help solve a small part of the retirement crisis that is already present for the current generation of retirees and pre-retirees. Second, I’d like to see what limitations will be put in place to stop parents from intentionally overfunding college for the purpose of taking advantage of this.

How to Prepare Clients

So, what can you do as an advisor while this works thought the legislative process?  In the short term, make sure your clients have complete records showing all the activity in their 529 accounts from the first deposit to today. Currently, 529 plans do not provide an official tax record showing deposits, only distributions. In light of this, it’s best to keep copies of all statements from the 529 provider. Supporting documents, including cancelled checks and bank statements showing electronic transfers, will also serve this purpose.

Although the legislation is still on the drawing board, you should consider incorporating anticipated changes in tax law into your review process.

John M. Gehri, CFP, ChFC is a licensed investment advisor representative with Harvest Financial Advisors in the Cincinnati/West Chester, Ohio area. He may be reached at This article is for informational purposes only. Any commentary and third-party sources are believed to be reliable but Harvest Financial Advisors cannot guarantee their accuracy.



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