Federal tax law allows you to roll over any or all of your 529 account from your current 529 plan to a different 529 plan, but only once in any 12-month period. (You can get around the 12-month restriction by naming a different family member as beneficiary of the 529 plan you are rolling into.) If you violate the 12-month rule, you must treat the transaction as a nonqualified distribution and pay federal tax and 10% penalty on accumulated earnings.
To transact a rollover, you can fill out the rollover contribution form available from the 529 plan you wish to move the money into. The administrator of your new 529 plan will then go about coordinating the transfer of funds directly from your old 529 plan. Alternatively, you can request a distribution from your old 529 plan, and within 60 days redeposit the amount of the distribution into a new 529 plan, informing the new plan that your contribution is a rollover and providing a breakdown between principal and earnings.
Rollovers do not routinely occur. Most 529 plan participants are satisfied with the plan they initially chose and see no reason to move the money to a different plan. In addition to the paperwork necessary to initiate a rollover, your plan may be one of the few that charges a fee to process a direct plan-to-plan rollover. What’s even more costly is the ‘recapture’ tax you must pay with your state tax return if you originally deducted your contributions and reside in a state that requires recapture of the tax benefit upon the rollover of funds to another state’s plan. (check your state’s 529 rules)
There are several good reasons for some 529 plan participants to consider doing a rollover. Here are the most common.
You want the lowest-cost 529 plan
Perhaps when you originally opened your 529 account, it was with the lowest-cost 529 plan. But competition being what it is, many 529 plans have been aggressive in reducing their fees and expenses, and your plan may no longer be the lowest cost. It doesn’t make sense jumping to a lower-cost 529 plan unless you can expect higher net returns. That can be a reasonable expectation if, for example, the underlying investments in your current 529 plan consist of index funds and you can find similar index funds in another 529 plan at lower cost.
Grabbing an in-state tax deduction
Let’s say you opened a 529 account with an out-of-state 529 plan, either because your home state did not offer a state income tax deduction for contributions, or because the deduction offered by your home state wasn’t enough to overcome deficiencies in cost, performance or investment choices. It may not be too late to take advantage of a state income tax deduction if your state now has one, provided it treats rollover contributions the same way it treats regular contributions. Some states do not count rollover contributions as eligible for a state income tax deduction.
Your 529 plan undergoes a manager change
States generally bid out the contracts for the management of their 529 savings programs, and every so often a state will rebid the contract and end up switching managers to a new investment firm. Although there is usually every reason to believe the change to be beneficial for plan participants, you don’t necessarily have to agree with it and you may decide to look elsewhere once the change in managers is announced. Even with no change in manager, a change in the menu of investment options, or in the underlying funds used, can be implemented at any time without your agreement. And if your state ever decides to terminate its 529 plan-Wyoming and Tennessee being prime examples–you’ll be forced to roll over to another state’s 529 plans if you want to avoid tax and penalty.
You expect poor performance to continue
As every investor should know, past performance is not a guarantee of future returns. But if your 529 plan has not been demonstrating good performance, as measured against its performance benchmarks or against competing 529 plans, you may feel it is in your best interest to switch to a different 529 plan with better-quality investments. Most 529 savings plans make their performance figures available on their web sites on a quarterly, monthly, or even daily basis. Because of the variety of options among 529 plans, and their relatively brief performance histories, comparisons are not easy to come by. Savingforcollege.com offers quarterly plan performance rankings for direct-sold plans, and investment professionals with a premium subscription can view performance for thousands of 529 portfolios and plan performance comparisons and rankings for advisor-sold plans.
You may have questions about setting up your 529 account, making changes to it, taking withdrawals, or even just understanding the quarterly statements and other information you receive online or through the mail. You can usually obtain help through the plan’s toll-free telephone number. Many plans allow you to handle your needs online with no delay. If you experience difficulties or frustration with your 529 plan, you will be tempted to move your account somewhere else in the hope of receiving better services.
Your current plan is too restrictive
When you signed up with your 529 plan, there may have been one or more restrictions in the plan not required under federal tax law. And although the restriction did not appear particularly troublesome at the time, you may now find yourself bumping up against it. One example is a grandparent who sets up the 529 account and later on decides the account is better managed by the parent of the grandchild. If the 529 plan is one of the handful of plans that does not allow an owner change prior to the original owner’s death or legal incapacity, the only way to get around this restriction is to roll over the account to a new 529 plan that accepts requests for owner changes.