529 Plan Rollovers And Transfers: Pros And Cons

It's time to talk about 529 plan rollovers and transfers.

Are you unimpressed with your current 529 account? Maybe the fees are too high or the website is hard to navigate. Perhaps you’ve moved and want to consolidate your 529 plans to a single state. 

Others may have recently learned that the son or daughter they've been saving for has decided to forgo college. If that's a situation you're facing, you may be thinking about transferring the funds to another child.

When you're considering 529 plan rollovers and transfers, you need to think through both the pros and cons before making any moves. In particular, taking tax implications (including clawbacks of previously taken deductions) into consideration is critical. These are some of the most important pros and cons of 529 plan rollovers and transfers.

529 Plan Rollovers Vs. Transfers

529 plan rollovers and transfers are two different strategies and have different benefits and drawbacks. Here's a quick definition of each:

• 529 Rollover: The process of moving your 529 funds to a different plan (in a different state).
• 529 Transfer: The process of changing the beneficiary within your existing 529 plan.  

529 Plan Beneficiary Transfer

With a 529 plan, you're allowed to change the beneficiary at any time to one of your beneficiary's eligible relatives. Examples include siblings and step siblings, parents, cousins,  aunts and uncles, and in-laws. Spouses of these family members are often considered eligible beneficiaries as well.

There are virtually no downsides to changing the beneficiary on your 529 plan. You can make a beneficiary change as often as you want without penalty.

But what if the new beneficiary already has his or her own 529 plan? In that case, you may want to consider a 529 plan rollover instead. Even if you're not looking to change beneficiaries, rollovers can make sense if you could switch to a plan with better options or lower fees.

While 529 beneficiary transfers have few drawbacks, 529 plan rollovers have important limits you'll want to be aware of in order to avoid tax consequences. Below, we cover the biggest pros and cons and 529 plan rollovers.

Pros Of 529 Rollovers

There are several reasons you may want to consider a 529 account rollover. Here are some of the benefits a 529 rollover may offer.

Better Investment Experience

Saving for college or graduate school is already challenging. But investing money for yourself or your loved one shouldn’t be a challenge. Unfortunately, many states have websites that make it tough to figure out how to invest in an automated fashion.

If you can find an easier account to use, you may be better able to set up an automated investment plan. For example, robo-advisor Wealthfront has a 529 plan (a state of Nevada plan) that makes it easy for contributors to save and invest on behalf of others.

Manage A Single Account

Parents who move across state lines may end up with two or more 529 plan accounts for each child. Managing a single 529 account is much easier and can make a lot of sense.

It may also make sense to combine accounts if a 529 account is inherited and the new custodian already has an existing 529 account for the beneficiary. This can make managing college savings easier.

Lower Account Fees

Unlike most retirement accounts, fees on 529 accounts can still be quite high. Some plans still have investment fees in excess of 1% per year.

Investors facing these high fees may want to rollover their accounts to a plan with lower fees or better investment options. Or if you're paying monthly service fees on multiple plans, combining them into one would also help to reduce your overall 529 plan costs.

Our 529 plan guide breaks down the 529 plan fees by state.

Lock In Current Tuition Rates

Cons Of 529 Plan Rollovers

Rolling over a 529 account may make sense in certain situations, but it’s not always a good idea. These are some of the drawbacks of 529 rollovers.

May Owe “Recapture” Taxes

Limited To One Rollover Every 12 Months

Each beneficiary can rollover a 529 plan once per year. But more rollovers can result in penalties. Most of the time, a once per year rule isn’t a big deal. However, it could be an issue if big life changes coincide. 

Investments Unlikely To Change Much

Most 529 plans offer similar investment options. Typically, these plans focus on mutual funds that mimic overall market performance. It's unlikely that switching plans will yield a significantly better investment result.

May Lose Time In The Market

Rolling over an investment account takes time. Between selling the old assets and transferring them to the new account, your 529 account could be out of the market for several weeks.

While this doesn’t sound like a big deal, missing out on a few big market days can make a difference in your long-term performance. Rolling over a 529 account could lead to accidental market timing. The result could be good, bad, or neutral. Regardless, it's a risk you'll want to be aware of.

Special Rollover: Changing Ownership

There is another type of rollover if you're going to change account owners, but maintain the same beneficiary. This is what happens when, say, a grandfather owns the 529 plan and wants to roll it over to the father. In this case, the beneficiary (the child) is the same, but the account owner changes.

The IRS allows one tax-free account owner rollover per 12-month period for 529 plans with the same beneficiary.

However, while no income taxes would be due, you may need to file a gift tax return depending on your situation.

Special Rollover: 529 Plan To IRA

The is another new type of rollover coming to 529 plans - the 529 Plan to Roth IRA Rollover. In the SECURE 2.0 Act, Congress will start allowing a rollover of up to $35,000 from a 529 plan to a Roth IRA. This limit is per person, not per 529 plan, so the limit applies regardless of the number of 529 plans. 

This is a great opportunity for individuals that may have "extra" money left in their 529 plan. Though, undoubtedly it will also be used by personal finance savvy folks as a backdoor method to get more money into their Roth IRAs. 

With that said, it's important to note a couple features of this type of rollover:

• The 529 to Roth IRA is an outbound rollover
• You still must comply with the Roth IRA Contribution Limits - meaning it may take five or six years to rollover the funds due to the lower IRA limits
• Each state has to allow it. Many states automatically comply with federal 529 plan rules, but others don't. Notably California, who doesn't allow K-12 education and other "new" 529 plan benefits. If your state doesn't allow it, and you go ahead with the rollover, you could be subject to 529 plan penalties. 

Make sure you find your state in our 529 By State Guide and see if they conform.

When To Consider A 529 Plan Rollover

Investments within 529 plans tend to be similar from state to state. Only details such as the investment experience, fees, and prepaid tuition options tend to vary among states. However, here are a few scenarios where rolling over your 529 account may make sense.

• You've always lived in a state with no state income tax.
• Your current (and any former states where you’ve lived) don’t offer tax deductions for 529 plan contributions.
• Your current or former state allows you to receive a state income tax deduction regardless of the 529 plan you use.

Be sure to check the rules carefully, because you don’t want to experience a state deduction “clawback” if you roll over to another state’s account. A CPA or a fiduciary financial advisor can help you determine which account makes the most sense for you.

If you do decide to rollover your old 529 plan to a new one, here are some of the best places to open a 529 plan today. Or if you're looking for a tool that makes it easy to automatically invest in new or existing 529 plans, you may want to consider Backer, where you can link your 529 plan account and start saving easier!