There are several reasons why someone might want to change 529 plans, such as plan underperformance, moving to a state that offers a tax deduction, or a state closing its plan. In cases like these, 529 account owners can roll over their funds without penalty.
When To Consider A 529 Plan Rollover
There are a few reasons why it may be a good idea to consider rolling over your 529 plan. If your current 529 plan involves high fees, such as annual maintenance fees, you could benefit from rolling over to a plan with lower fees. Equally, if you have more than one state 529 plan, consolidating your assets can make things easier to manage and minimize the fees you have to pay.
Another common reason for a 529 rollover is that you’ve recently moved to a new state. Some states provide tax benefits for contributions, but not all do. If you’ve moved to a state offering such benefits, rolling over your plan could help you optimize your tax return. Or you simply may not like the service offered by your current 529 plan and want an upgrade.
529 Plan Rollovers vs. Transfers
A 529 rollover transfers funds to another 529 plan, whereas a transfer changes the plan’s beneficiary. You can easily change the beneficiary of your 529 plan anytime without penalties, as long as the new beneficiary is an eligible family member. If the new beneficiary already has a 529 plan, you can roll over the funds to that account. Depending on your situation, a rollover or a transfer could be beneficial.
Advantages of a 529 Plan Rollover
- It can make things easier by only having to manage one account
- You’ll minimize costs by only paying one set of fees inside of two or more
- You can optimize your investment objectives by choosing the most user-friendly plan
- You can now roll over a 529 plan to a Roth IRA
Advantages of a Transfer
- They’re tax-free in nearly all cases
- You can transfer as often as you want, whereas you’re limited to one 529 rollover every 12 months
- Transfers are typically processed faster than 529 rollovers, which can take time. This means that you lose time in the market, which could impact your investment over the long term.
Alternatively, you can roll over a 529 plan to a different owner. This is a Special Rollover when you keep the same beneficiary while changing the account owner. In this case, the same tax rules apply as other 529 rollovers.
Steps to complete a 529 rollover
Follow these steps to complete a 529 rollover to another 529 plan.
1. Choose Your New 529 Plan
Research different 529 plans from various states, especially if you want lower fees or better investment options. If you’re moving to a new state, consider whether that state offers tax benefits for contributions.
2. Verify Eligibility for a Rollover
Ensure you haven’t rolled over a 529 plan for the same beneficiary within 12 months. This rule ensures that you maintain tax-free rollover status.
3. Initiate the Rollover
You have two options for transferring the funds:
- Direct Rollover: Complete the rollover form provided by the new 529 plan administrator, and they will handle the transfer on your behalf.
- Indirect Rollover: Withdraw the funds from your current 529 plan and deposit them into the new plan yourself. Remember, you must complete this transfer within 60 days to avoid taxes and penalties.
4. Check for Recapture Tax Rules
If you’ve claimed a state tax deduction for contributions, check whether your state requires you to repay any benefits if you roll over to another state’s plan. For more on recapture tax rules, see the section below.
5. Confirm the Transfer
Once the rollover is complete, verify that the funds have been deposited into the new 529 plan and that no taxes or penalties have been applied to the rollover.
Questions to ask yourself before doing a 529 Plan Rollover
Before you make any changes to your plan or move forward with a 529 plan rollover, ask yourself these five questions:
1. Have You Recently Done a 529 Plan Rollover?
529 plan 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 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. However, 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 roll over your 529 college savings plan. You can either fill out a rollover 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. Over 100 different plans are available from almost every state, and Savingforcollege.com offers helpful comparison tools that can assist you with your choice.
RELATED: How can I roll over funds without incurring taxes?
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 valid rollover and 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. Can You Get Around the 12-Month Limit?
529 plan rollover rules place certain limitations on rollovers. Any additional rollovers for the same beneficiary per 12-month period will be considered to be a non-qualified distribution.
If the new beneficiary is not a member of the old beneficiary’s family, the rollover will be considered a non-qualified distribution. The earnings portion of a non-qualified distribution is considered to be a taxable distribution and is reported as income on the FAFSA.
To avoid paying taxes and penalties 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 made as often as you need, so after you roll over 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. Will You Owe ‘Recapture Tax’ to Your State?
As mentioned above, 35 states, including the District of Columbia, allow residents to claim a tax deduction or credit for 529 plan contributions. Most states require you to use your home state’s plan, but seven states will offer a tax break for contributions to any 529 plan.
Check the recapture rules if you’ve been deducting contributions on your state tax return and decide to roll over your funds to another state’s plan. This could end up being a costly surprise on your state tax return.
Check the rollover rules if you’re changing plans because the new plan offers a state tax deduction for contributions. 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.
RELATED: How much is your state’s 529 plan tax deduction really worth?
