FIRE Hack: 529 Plans Conversion to Roth IRA

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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.
  • 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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Image credit: Sincerely Media

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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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