529 to Roth Conversion

Submitted by Patrick Larkin on Mon, 2024-01-08 15:22

1. When transferring funds from a 529 to a Roth do earnings and basis have to transfer pro rata or can earnings alone transfer? With the $35k life time cap on transfers this is an important nuance. Ideally earnings transfer and the basis can remain in the 529 reducing impact of non-qualified 529 distributions.

2. If later a Roth IRA owner takes a pre 59.5 distribution from the funds that used to be in a 529 are these funds considered a return of contribution and therefore a non-tax and penalty free event or are some or all of the funds considered earnings?

The answer likely is – awaiting IRS guidance?

Thanks,
-Patrick



Submitted by Alan - IRA critic on Mon, 2024-01-08 16:32

  1. Pro rata. A proportional amount of the 529 contributions and earnings would be treated as regular Roth IRA contributions and earnings. The remaining 529 balance will therefore contain a lower amount of contributions and earnings than before the transfer. Sec 126 of Secure 2.0 is clear on this point.
  2. Roth ordering rules will apply to subsequent Roth IRA distributions, the Roth IRA regular contribution basis being increased by the amount of 529 contributions transferred, with the balance increasing Roth IRA earnings. Taxpayers tracking of Roth IRA basis must be updated after the transfer to enable Roth IRA distributions to be properly reported on Form 8606.

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