Can I Roll a Traditional IRA Into a 529 Plan for My Grandchild?

If you have money in a traditional IRA that you'd like to put into a grandchild's 529 plan, you can't simply roll it over from one account into the other. Instead, you'll have to take a distribution from the IRA and then put the money into the 529 plan. This means you'll have to pay income taxes on the amount you withdraw as well as a 10% tax penalty if you are under age 59½. Fortunately, there are better ways to accomplish the same goal. This article gives you some tips if you want to take money from your IRA to sock away into a 529 plan for your grandkids.

Using Your Required Minimum Distributions

You must generally take the required minimum distributions (RMDs) from your traditional IRA each year after age 73. The RMD age used to be 72, but the passage of the SECURE 2.0 Act by the U.S. Congress increased the age to 73.

If you don't need that money for living expenses, you can reinvest it however you see fit. This includes putting the money into a grandchild's 529 plan. Keep in mind, though, that you'll still have to pay income tax on the distribution, but there was no avoiding that anyway.

Taking an IRA Distribution for Education Expenses

If you are under age 59½, you can get around the 10% early withdrawal penalty by using your IRA distribution to pay for some of your grandchild's qualified higher education expenses. These expenses include:

• Tuition
• Mandatory fees
• Room and board
• Certain other costs

Again, you'll still have to pay income tax on the distribution regardless of your age.

Funding the 529 Plan With Other Money

Because it's difficult (if not impossible) to avoid taxes when taking money out of a traditional IRA, a better move—if you can afford it—would be to contribute to your grandchild's 529 plan either out of your earned income or by cashing in other non-retirement assets, such as money in a mutual fund that is outside of your IRA.

If you take a distribution from non-retirement accounts, you'll still owe some tax, but it's likely to be at a lower rate. Mutual fund distributions are taxed as long-term capital gains as long as you've owned the shares for at least a year, while traditional IRA distributions are taxed at the same rate as your ordinary income, which is generally higher.

How Much Can You Contribute?

Regardless of where the money comes from, there are some limits to how much you can contribute. Giving your grandchild more than $16,000 in 2022 and $17,000 in 2023 ($32,000 and $34,000 if you and your spouse both contribute) a year will generally trigger federal gift taxes.

The IRS does allow you to front-load your contributions to a 529 plan by making up to five years' worth of gifts at one time. That's $80,000 in 2022 and $85,000 in 2023 ($17,000 per year multiplied by five years) for one person or $160,000 and $170,000 for a couple.

The states, which administer 529 plans, also set limits on how much money total can be contributed to single 529 accounts. As of 2022, those limits range from $235,000 to $550,000, depending on the state.

Note, however, that gift tax limits don't apply if you pay money toward your grandchild's tuition directly to the educational institution. This is known as the educational exclusion, and it applies only to tuition, not to other expenses.

What About Roth IRAs?

If you have a Roth IRA as opposed to a traditional one, the rules are different. Withdrawals from a Roth account are not taxed as long as you meet certain requirements. And you can withdraw your contributions to the account (as opposed to the account's earnings) at any time without penalty.

Of course, the downside of taking money from a Roth IRA to fund a 529 is that you'll be giving up the tax-free growth that the Roth provides and ultimately have that much less money available to you when you retire.

That said, a Roth IRA can be a good way to save for a grandchild's college education, particularly if you're unsure whether they'll need your financial help. If the grandchild does need your assistance, you can take money out of the Roth tax-free. If not, you can just keep it there for your retirement.

The Bottom Line

You may every great intention to help a future generation fund their education by funding a 529 plan. However, you must be considerate on how that account is funded. There are tax implications if funding is rolled from a traditional IRA; however, rolling over funds from a Roth IRA (assuming you only withdraw contributions) may be a valid tax-avoidance strategy. Otherwise, it may be best to simply directly fund the plan.