How to Roll a Traditional IRA into a 529 Plan for Your Grandchild

If your grandkids are ready to go to college or even if they plan to do so in the future, you may have probably thought about how you can help out. College is anything but cheap, and if you have already been through it with your own kids, you know exactly how stressful and expensive it can be.

So now, watching your children go through the same thing with your grandkids, you may want to step in and make things a little easier. You could cover part of the tuition, help lower the need to take on a student loan, or even cover the costs of their boarding, groceries, and other expenses.

But the main question here that might cross your mind is, can you use your retirement savings to do this? More specifically, can you roll an IRA into a 529 plan? There are a few important details you need to understand before you go ahead. Let’s discuss this option in detail and the alternatives at your disposal.

Can I move money from an IRA to a 529 tax-free?

The short answer is no. You can’t do this. There is no provision that allows you to directly move money from a Traditional IRA to a 529 plan. Because of that, there is also no way to do this tax-free.

Let’s take a step back for a moment.

A Traditional IRA is short for an Individual Retirement Account. It is designed to help you save for retirement while enjoying tax advantages. Typically, you may get a tax deduction when you contribute to the account, and your investments grow without being taxed after that. This gives your money the chance to grow tax-free, which can lead to better growth over time. However, when you withdraw money in retirement, your withdrawals will be taxed as any other income. They will be added to your annual income, and you will pay tax as per the tax slab you fall into.

Because of this structure, the Internal Revenue Service (IRS) has restrictions on how the money can be used. You can’t simply transfer or roll over funds from a Traditional IRA into just any account. It has to stay within the retirement account unless you take a distribution.

So, if you do decide to withdraw your money and then transfer the IRA funds to a 529 plan to cover your grandkids’ education expenses, the withdrawal would be taxable, and depending on your age, it could also come with an additional penalty.

So, if you can’t roll an IRA into a 529 plan, what do you do instead?

The option to roll over an IRA to a 529 is certainly not available right now. But you have another way around this. Let’s understand the options you have:

1. Withdraw your funds and use them for your grandchild’s education

If you are thinking about using your Traditional IRA to help fund your grandchild’s education, the most straightforward way to do it is to withdraw the money and then use it as you see fit. There is no direct way to transfer an IRA to a 529 plan.

Traditional IRA rules mandate a specific age at which you need to make withdrawals. You are generally required to take Required Minimum Distributions (RMDs) from your Traditional IRA each year after age 73. At that point, the money has to come out anyway, whether you need it for yourself or something else. Once you withdraw it, you are free to use it however you like. This includes contributing to your grandchild’s 529 plan. However, there is one thing you cannot avoid. You will still have to pay income tax on the amount you withdraw. Since traditional IRA contributions are made with pre-tax dollars, the money is taxed when it comes out. So, it is not a tax-free move. This is why you really need to evaluate the consequences of your withdrawals before you decide to draw money.

Now, let’s say you have not reached the RMD age and you are not even 59½ yet, but your grandchild is in need of money. There is an exception in this case that can help.

If you take money out of your IRA before age 59½, there is usually a 10% early withdrawal penalty on top of regular income tax. However, the IRS does allow you to avoid this additional penalty in certain situations. One such situation is when the money is used for qualified higher education expenses. This exception can really help you as it allows you to withdraw funds early without paying the extra 10% penalty if the money is used for education costs for yourself, your spouse, your child, or your grandchild. These qualified expenses typically include tuition and other mandatory fees required by the institution. They can also include room and board. In addition, certain other related costs may qualify, depending on the situation and the educational institution your grandkid goes to. But even with this exception, it is important to remember that the withdrawal is still subject to income tax. The penalty may be waived, but the tax is not.

So, if you are considering this route, it helps to plan it with a financial advisor. While you may want to help your grandchildren, you still need to think about how it will affect your overall tax situation in retirement.

2. Use an Education IRA

Did you know there is something called an Education IRA? It is more commonly known as a Coverdell ESA, and it is specifically designed to help you save for a grandchild’s education. An education IRA is not like the usual Traditional or Roth IRAs you may have heard of. Unlike these, an education IRA is set up as a trust for a specific child as the beneficiary. The money can be used for college expenses, yes. But that is not all. You can also use the funds for a wide range of other education-related costs, including primary and secondary schooling. Eligible expenses include tuition, books, equipment, etc.

Here’s the eligibility criteria for a Coverdell ESA:

• You can open an account for a grandchild under the age of 18. But if the beneficiary has special needs, the account can also be opened after age 18.
• You can continue contributing to the account until your grandchild turns 18. However, if the beneficiary has special needs, you can continue contributing to the account after age 18 as well.

The important thing to note is that the money in the account must typically be used by the time the beneficiary turns 30, and the account must be closed by then. If not, there could be taxes and penalties involved. You could get some waivers if the beneficiary has special needs. But in other cases, it is best to use the money before the child turns 30.

Another important thing you must know about education IRAs is how they are taxed. Contributions are made with after-tax money, unlike a Traditional IRA. The investments in the account grow tax-free over time.

Now, you may think that if the investments are not taxed, then the withdrawals would be, right?

The good news is that even withdrawals from an education IRA are tax-free, as long as the money is used for qualified education expenses. This can help you lower your tax liabilities and support your grandchild in getting through school and college comfortably. However, withdrawals must not exceed the beneficiary’s qualified education expenses for the year. If you withdraw more, the excess amount will be taxed at the beneficiary’s regular income tax rate.

Anyone can contribute to an education IRA. This includes parents, grandparents, and even trusts. So, as a grandparent, you can certainly explore this option. Using an education IRA can also be a much simpler approach. Instead of trying to figure out how to roll over an IRA to a 529, you just use a single account that is already designed for education and offers great tax benefits.

3. Give your grandchildren the money as a gift

You may have heard of the gift tax, but are you aware of its exemptions? The IRS allows you to give up to $19,000 per person per year without triggering any gift tax. This is known as the annual exclusion. Under this provision, you can give up to $19,000 to each grandchild each year without worrying about additional taxes or reporting complications, in most cases.

For example, if you have four grandchildren, you can give each of them $19,000 in a single year. That adds up to $76,000 annually, all of which is tax-free under the annual exclusion rules. And the best part is that this resets every year. So, if you give $19,000 to each grandchild in 2026, you can do the same again in 2027, subject to the limits of the concerned financial year.

You can also give away up to $15 million over your lifetime without paying gift taxes. Gifts above the annual limit do not count toward this lifetime exemption.

You can decide how much money you wish to give, and your grandchildren or their parents can then choose how to use the money. Pretty straightforward, right?

4. Pay the tuition directly to the college instead of giving the money to your grandchildren

Another simple way to help your grandchildren is to pay their tuition directly to the college. When you make tuition payments straight to an accredited educational institution, they are not considered gifts for tax purposes and do not count toward your annual gift tax exclusion of $19,000 per person. So, you can cover as much of the tuition as you want without using up your yearly gifting limit. At the same time, you can still give your grandchild up to $19,000 separately in the same year if you choose to.

There are a couple of things to keep in mind, though. The payment must be made directly to the institution. If you give the money to your grandchild or their parents and they pay the tuition, it will be treated as a gift and count toward your annual limit. Also, this rule applies specifically to tuition. Other expenses do not qualify under this exception.

5. Open a 529 account yourself

Instead of transferring an IRA to a 529 plan, why not just use the 529 in the first place?

As a grandparent, you have two options here. You can either open and own the 529 account yourself, or you can contribute to an existing account that is owned by the child’s parents. When you open your own 529 account, you stay in control of the funds. You decide how the money is invested and used. There can also be tax benefits depending on where you live. In some states, contributions to a 529 plan may be eligible for a state income tax deduction. The exact limits and rules vary by state.

If you contribute to a parent-owned account instead, you may not qualify for the same deduction. But it can still be a good option if you prefer a simpler route and want to support your grandchild without managing the account yourself.

Either way, a 529 plan offers tax advantages as investments grow tax-deferred and withdrawals are tax-free when used for qualified education expenses.

Can you roll an IRA into a 529 plan? No, but you can do more

You cannot roll an IRA into a 529 plan, so that option is off the table. But that does not mean you are out of ways to help. You can withdraw funds from your IRA and use them to cover education expenses, contribute to or open a 529 plan, use an education IRA, gift money within the allowed limits, or even pay tuition directly to the institution.

The important thing to understand is that these strategies work best when you plan ahead. Talking to a financial advisor can help you sort through your options and choose an approach that fits both your retirement goals and your grandchildren’s needs. Our financial advisor directory can be a great place to look for a financial advisor in your city.

Frequently Asked Questions (FAQs) about education planning

1. What is Free Application for Federal Student Aid (FAFSA)?

The Free Application for Federal Student Aid (FAFSA) is a form used to determine a student’s eligibility for federal financial aid for college. The exact aid a student receives depends on the family income and overall financial situation.

2. Is a 529 plan better than a Traditional IRA for education savings?

In most cases, a 529 plan may be better suited for education savings than a Traditional IRA. A 529 plan is specifically designed for education. It offers tax advantages and flexibility to pay for qualified education expenses. Your investments grow tax-deferred, and withdrawals are tax-free if used for qualified expenses. A Traditional IRA, on the other hand, can be used for education in certain situations, but its main purpose is retirement.

The better option really depends on your goals and overall financial situation. If you are unsure, speaking with a financial advisor can help you choose the right option.

3. Should you prioritize your grandchild’s education over your own retirement?

From an emotional standpoint, you may want to put your grandchild’s education first, but financially, that is usually not the best decision. Your grandchild has more options for funding education. They can apply for scholarships, work to earn money, or take out student loans, if needed. You, on the other hand, may not have the same flexibility when it comes to retirement.

For additional information on retirement planning strategies tailored to your specific financial needs and goals, please visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm that manages private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services tailored to each client’s unique needs, providing institutional-caliber money management services based on a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.