How Do I Convert a 529 to an IRA?
A qualified tuition plan, sometimes called a 529 plan, provides tax benefits when used to pay for qualified education costs. You contribute after-tax dollars to a QTP -- these contributions are not deductible. Earnings can accumulate and be withdrawn tax-free as long as they are used for qualified education expenses. The beneficiary of a QTP must be a family member.
You can’t convert a QTP to an IRA. Normally, any distribution of earnings for any purpose other than qualified education expenses is taxable and incurs an additional 10 percent tax. You can contribute the money you distribute from a QTP to an IRA, but it is not a tax-free rollover and is subject to the annual IRA contribution limits. In 2013, you can contribute up to $5,500 to an IRA, or $6,500 if you’re 50 or older. You cannot contribute more than your gross income.
The Internal Revenue Service grants certain exceptions to the 10 percent additional tax on earnings you withdraw from a QTP that don’t go toward qualified education expenses. These include the death or disability of the beneficiary. They also include cases where the beneficiary receives a tax-free scholarship, veteran’s assistance, employer assistance or other tax-free educational assistance. However, gifts and inheritances don’t qualify for exemption. Other exemptions include attendance at a U.S. military academy and income caused by certain federal learning credits.
If you establish a QTP and the beneficiary doesn’t attend college, you might consider designating a new beneficiary rather than withdrawing money from the plan. For example, you might be able to name a relative from the generation following that of the former beneficiary, such as a grandchild. The state rules governing QTPs may impose age or grade limits on beneficiaries. By redesignating the beneficiary or rolling the QTP into another QTP, you avoid taxes and penalties on non-qualified distributions. In addition, the money in a QTP is not subject to estate taxes -- if you withdraw the money, it rejoins your estate.
You can roll over distributions from a QTP to a different QTP as long as you complete the process within 60 days. You do not have to report QTP rollovers or changes of beneficiary on your federal tax return. The list of eligible beneficiaries is extensive and includes ancestors, step-relatives, in-laws, cousins and the spouse of any eligible beneficiary. If you make a taxable distribution from a QTP, figure the additional tax on IRS Form 5329 and report the amount on Form 1040.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.