Are 529-to-Roth IRA Rollovers Subject to State Tax?
Rollover opportunities from 529 plans to Roth IRAs are a recent benefit introduced under SECURE 2.0, designed to expand tax-advantaged savings options for Americans. While these rollovers are tax-free at the federal level if specific rules are met, the same cannot always be said for state taxes. Each state handles 529-to-Roth IRA rollovers differently, creating a patchwork of tax policies that savers need to navigate carefully.
This article unpacks the intricacies of 529-to-Roth IRA rollovers, explains how SECURE 2.0 governs these transfers, and dives deep into how various states approach this issue. By the end, you’ll have the clarity to make informed decisions while keeping potential tax liabilities in mind.
Understanding the Federal Rules for 529-to-Roth IRA Rollovers
The SECURE 2.0 Act introduced significant updates to retirement and education savings plans, including the ability to roll over unused 529 plan funds into a Roth IRA. Here’s a breakdown of the key federal requirements:
- Lifetime Rollover Limit: A maximum of $35,000 can be rolled over from a 529 plan to a Roth IRA over the account’s lifetime.
- Account Age Requirement: The 529 plan must have been open for at least 15 years to qualify for a rollover.
- Contribution Limits Apply: The amount rolled over in a year cannot exceed the annual Roth IRA contribution limit ($6,500 in 2024 for individuals under 50).
- Aggregation with Other Contributions: The rollover amount counts toward the total annual contribution limit for the Roth IRA, including regular contributions.
When these conditions are met, the rollover is tax-free at the federal level. However, the treatment of these transfers at the state level varies significantly.
State Tax Considerations for 529-to-Roth IRA Rollovers
At the state level, the tax treatment of 529-to-Roth IRA rollovers is anything but uniform. While some states conform to federal tax rules, others impose additional taxes or require the recapture of state tax deductions previously taken for 529 contributions.
States Conforming to Federal Law
Twenty-one states align with federal rules, meaning 529-to-Roth IRA rollovers are tax-free for their residents. These states include:
- Alabama, Arizona, Delaware, Georgia, Hawaii, Idaho, Kansas, Kentucky, Maine, Maryland, Nebraska, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Virginia, West Virginia, and Wisconsin.
If you live in one of these states, you’re in luck—rollovers won’t create an additional state tax burden.
States with Tax Recapture Rules
Several states allow residents to claim state tax deductions or credits for 529 contributions. However, if those contributions are later rolled into a Roth IRA, residents may face state income tax recapture. This means you’ll have to repay the tax benefit previously received. The 10 states with recapture rules are:
- Illinois, Indiana, Iowa, Massachusetts, Michigan, Minnesota, Montana, New York, Utah, and Vermont
For example, in New York, taxpayers can deduct up to $10,000 in 529 contributions annually. However, rolling over funds from a 529 plan into a Roth IRA triggers a tax recapture on those deductions.
How California Treats 529-to-Roth IRA Rollovers
California takes a unique approach to 529 rollovers. While it does not offer state tax deductions for 529 contributions, California imposes both:
- State Income Tax: Taxing any earnings from the rollover.
- Additional 2.5% Tax: A separate penalty on rollover earnings.
This makes California one of the least favorable states for 529-to-Roth IRA rollovers.
Unclear or Pending State Policies
For residents of the following states and the District of Columbia, the state-level tax treatment of 529 rollovers remains uncertain:
- Arkansas, Colorado, Connecticut, Louisiana, Mississippi, Missouri, New Jersey, Oklahoma, Rhode Island
Until these states provide clear guidance, taxpayers should consult with a Certified Financial Planner or tax advisor before rolling over 529 funds.
529-to-Roth IRA Rollovers: The Federal Perspective
Federally, 529-to-Roth IRA rollovers offer significant tax advantages. By meeting the criteria set forth under SECURE 2.0, account holders can repurpose unused education savings into retirement funds without incurring penalties or taxes.
The primary benefits include:
- Avoiding penalties on unused 529 funds.
- Encouraging long-term retirement savings.
- Ensuring a tax-efficient transfer process.
In Summary
529-to-Roth IRA rollovers present a promising solution for unused education savings, but understanding state-specific tax implications is essential. While federal rules provide a clear framework, state policies vary widely, with some offering full alignment, others imposing recapture provisions, and a few adding extra taxes.
Taxpayers should consult with financial professionals to navigate these complex rules and optimize their savings. By staying informed, you can make educated decisions that support both your financial goals and compliance with state laws.
FAQs
Can I roll over any 529 plan to a Roth IRA?No, the 529 plan must be at least 15 years old, and contributions made within the last five years are ineligible.
What is the lifetime limit for 529-to-Roth IRA rollovers?The federal lifetime limit is $35,000 per beneficiary.
Are rollovers subject to state tax in all states?
No, tax treatment varies by state. While some states follow federal rules, others impose taxes or recapture provisions.
Is California’s additional 2.5% tax unique?
Yes, California is the only state to impose this extra tax on 529-to-Roth IRA rollovers.
Do states with no income tax impose rollover taxes?
No, states without income tax—like Texas and Florida—do not tax 529 rollovers.
Can I claim a tax deduction for 529 contributions and still roll over funds?
In some states, you may be required to repay deductions (via recapture) if you roll over funds to a Roth IRA.
Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.
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