Learn the specific rules and requirements for transferring funds between IRAs and 529 plans so you can make informed financial decisions for the future.
Building up savings for college or retirement can get a lot easier if you use a tax-advantaged account, a variety of which is available for families and individuals. From 401(k)s to IRAs and 529 plans to Coverdell education savings accounts, the wealth of choices can make it tough to choose the account that’s right for you, which is why many proactive savers find themselves wanting to switch from one type of account to another. Given the tax implications many of these plans carry, however, transferring funds from one to another is often easier said than done, and in some cases, it’s simply impossible. Therefore, if you have a 529 plan or an IRA, you could very well end up asking yourself: “Can I roll a 529 plan into an IRA or vice versa?” To find out, keep reading as the college savings experts at Sootchy cover this important topic.
To answer the question of whether you can roll a 529 plan into an IRA, it helps to look at the tax benefits of each, which are ultimately what guides decisions about what’s allowed with these accounts. Let’s consider the features of each account briefly:
Contributions are made with after-tax dollars. Any gains on these accounts are free from federal income tax – as well as state income tax, in many cases – as long as they’re used for qualified education expenses. Plans come in three forms: prepaid tuition plans, education savings plans, and ABLE accounts. The details of a plan can vary widely from state to state.
The traditional form of the IRA is an account that allows owners to make tax-deductible contributions. Because of the opportunity to take a deduction, IRA funds essentially comprise pre-tax income, and gains can grow tax-free as well. As long as the money in an IRA is used after retirement, there’s no penalty, but gains are taxed when funds are withdrawn from the account.
This popular version of the IRA works similarly to a 529 plan in many ways. Contributions to the account are made with after-tax income, for instance, and withdrawals are tax-free when taken in retirement (as long as the account owner has met the proper conditions) and in a few other circumstances. Also, unlike traditional IRAs, there are no required minimum distributions from a Roth account.
Because the tax implications of a 529 plan don’t precisely match up with those of IRAs, it’s against the rules for 529 plan owners to transfer their funds directly from that account into one designed for retirement. That said, you can choose to withdraw the money in your 529 plan at any time – getting hit with taxes and a 10% penalty in the process – and deposit those funds in an IRA, so the option is not out of the question, though it can be costly.
Though it’s clear that you can’t roll a 529 plan into an IRA, how about vice versa? As mentioned above, the tax differences between IRAs and 529 college savings plans preclude the possibility of folding one into another, so you can’t simply roll a Roth IRA into a 529 plan. That said, you do have more options when it comes to moving funds from an IRA to a 529 plan than vice versa.
Whereas a traditional IRA doesn’t allow withdrawals before retirement (except in cases of a birth, adoption, first home purchase, and certain college-related expenses), a Roth IRA offers more flexibility, at least where contributions are concerned. Should it become necessary, the owner of a Roth IRA can withdraw contributions – but not earnings – from their account without having to pay any taxes (unsurprising, since it’s after-tax money to begin with) or penalties. That money is then free to be used however the owner would like, including as a contribution to a 529 plan.
While there are a considerable number of similarities between 529 plans and IRAs (of both types), the benefits of each are specifically designed to meet certain needs. In the case of a 529 plan, that need is the funding of higher education – which can include tuition, housing, supplies, and other costs – as well as primary and secondary education, in some cases. IRAs, on the other hand, are meant to help people fund their lives after they’ve stopped working, and the ways each of these investment accounts function reflect these aims.
Take the 529 education savings plan, for instance. Not only do contributions grow tax-free, but adding to one of these accounts can bring state income tax benefits as well, which helps make college more affordable for families, and relatives can often contribute to 529 plans. These accounts also come with a variety of investment options that are often tailored to an 18-year timetable – the time it takes for a newborn to reach college age. However, using a 529 plan for anything other than its stated purpose can lead to penalties, and the same rule applies to IRAs.
Although it can sometimes be tricky to navigate the nuances of the various tax-advantaged savings plans out there, opening a 529 plan can be easy with some help from the experts at Sootchy. Download the Sootchy app today to open, manage, or contribute to a plan with ease; learn more by visiting us online.