5 things to consider before doing a 529 plan rollover
There are a number of reasons why someone might want to change 529 plans. Perhaps your plan has been underperforming, or you maybe you moved and your new state offers a tax deduction for contributions. In the rare event that a state closes a plan, such as Tennessee’s prepaid tuition program, account owners have the option to rollover their account value into a 529 college savings plan without penalty.
But before you make any changes to your plan, ask yourself these five questions:
1. Have you recently done a 529 plan rollover?
529 plans owners are limited to just one tax-free rollover in a 12-month period. This rule applies per beneficiary, not per plan. For example, let’s say you moved to another state and you want to transfer the funds in your son’s existing 529 plan to a plan in the state you reside in because they offer a tax deduction for contributions. But your father (the child’s grandfather) also has a 529 plan with your son named as the beneficiary. You’ll need to make sure that he hasn’t done a rollover within the last 12 months, or your transaction will be considered a non-qualified withdrawal. The earnings portion of non-qualified withdrawals will be subject to income tax as well as a 10% penalty.
RELATED: When should you switch 529 plans?
2. Have you selected your next plan?
There are two ways you can rollover your 529 college savings plan. You can either fill out a rollover distribution form for the new plan and let the plan administrators handle the transfer, or you can take a distribution from your existing account and deposit the money into the new plan as a rollover contribution. Regardless of which method you choose, the funds will need to be moved to the new plan within 60 days of the withdrawal from the old plan. If you miss the 60-day window the withdrawal will be considered non-qualified.
Before you initiate a rollover, be sure to explore all of your options when it comes to opening a 529 plan. There are over 100 different plans available from almost every state, and Savingforcollege.com offers helpful comparison tools that can assist you with your choice.
3. Is it really a rollover?
If you’re moving funds from one 529 plan to another, it’s considered a rollover and can only be done tax-free once in a 12-month period. But what If you want to use the money from an existing Coverdell ESA to open a 529 plan? While this transaction will still be tax-free, it’s not considered a true rollover and therefore is not limited to once per 12-month period. The same applies if you redeem certain Series EE or I bonds purchased after 1989 by someone age 24 or older and deposit the proceeds into a 529 plan. There won’t be any tax consequences, and it won’t count toward your rollover limit.
RELATED: Coverdell ESA versus 529 plan
4. There may be a way to get around the 12-month limit
To avoid paying taxes and penalty on a 529 rollover if you’ve already done one in the last 12 months, you’ll just need to designate another qualifying family member as the beneficiary on the new account. According to IRS Publication 970, this can be a sibling, spouse or even a first cousin. Beneficiary changes can be done as often as you need, so after you rollover your funds you can simply change the beneficiary back to the first child.
Changing the beneficiary can also help if you want to make more than two investment changes during a calendar year. The IRS allows two investment option changes during a calendar year, but if you want to make a third change you can request a beneficiary change along with the investment option change request.
RELATED: The magic of beneficiary changes
5. You may end up owing ‘recapture tax’ to your state
35 states, including the District of Columbia, allow residents to claim a tax deduction or credit for 529 plan contributions. The majority of these states require you to use your home state’s plan, but seven states will offer a tax break for contributions to any 529 plan. If you’ve been deducting contributions on your state tax return and decide to rollover your funds to another state’s plan, be sure to check the rules regarding recapture. This could end up being a costly surprise on your state tax return.
If you’re changing plans because the new plan offers a state tax deduction for contributions, check the rules regarding rollovers. Some plans will allow you to claim a deduction for a portion of the rollover contribution. For example, only the principal portion of the rollover may be eligible for a deduction, and the maximum annual deduction will vary by state.
A good place to start