You cannot roll over a traditional individual retirement account (IRA) into a 529 plan without paying taxes. The Internal Revenue Service (IRS) considers putting an IRA distribution into a 529 plan as a distribution included in your taxable ordinary income.

Beyond the income tax, you would also face an additional 10% tax penalty for the early withdrawal if you are not yet 59½ years old. After those taxes, you could contribute what’s left to the 529 plan.

Thus, funding a 529 account from a traditional IRA is not a good idea. Consider these alternatives instead.

Key Takeaways

  • You can’t roll over your IRA into a 529 plan without taking a tax hit and, in some cases, paying a penalty, too. 
  • Better options include using an IRA distribution to pay for education expenses or funding a 529 with regular income. 
  • All 50 states offer 529 savings plans to help families save for higher education expenses.

Use an IRA Distribution to Fund Education Expenses

Rather than opening the 529, you might consider using the IRA distribution for education expenses. Withdrawals from your traditional IRA for the purposes of higher education are exempt from the 10% penalty. This exemption applies to Roth IRAs as well.

Penalty-exempt expenses include “tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution,” according to the IRS. You should visit the IRS website to get a full breakdown of the exempt qualified higher education expenses.

Remember, the higher education expense would exempt you from the 10% penalty, but the distribution would still incur the ordinary income tax. In addition, the distribution may need to be included as income on any financial aid applications, especially the Free Application for Federal Student AID (FAFSA), so be sure to time it carefully.

There are two types of 529 plans: prepaid tuition plans and savings plans.

Fund a 529 With Regular Income

Finally, you might consider opening a 529 plan and contributing to it from your regular income rather than from your IRA. This way you can avoid both the ordinary income tax and early withdrawal penalty of your IRA and begin to grow a college fund.

Another benefit is that grandparents (and parents) can contribute up to $15,000 (in 2019 and 2020) to a 529 plan per child annually without incurring gift taxes. If married, each grandparent (and parent) can contribute up to $15,000, for a total of $30,000 per couple. Very wealthy families can even frontload 529s by contributing five years of gifts ($75,000 per giver/per child) at once, to allow maximum time for earnings growth. In addition, many states’ 529 plans allow the account owner to take a full or partial state income tax deduction for contributions to the plan. If you’re not sure of the best strategy for your particular state and situation, you should reach out to a financial advisor for guidance.