You cannot transfer funds from a 401(k) or IRA into a 529 plan. Any distribution you take from your retirement plan for the purpose of depositing it into a 529 plan will be taxed and may also be subject to an early withdrawal penalty.
However, you may be able to take a penalty-free distribution from your retirement plan to pay for college costs. The distribution will still be subject to income tax and may affect eligibility for need-based financial aid.
IRA withdrawals used to pay for qualified higher education expenses are not subject to a 10% early-withdrawal penalty. You may also be able to rollover a 401(k) into an IRA and then take a penalty-free distribution from the IRA to pay for college costs. You can also use a tax-free return of contributions from a Roth IRA for any purpose, including college costs.
There are several types of transfers into and out of a 529 plan that can be accomplished without triggering federal income taxes. The most common are the following:
- From a Coverdell education savings account (ESA) to a 529 plan. Simply withdraw from the Coverdell ESA and make sure contributions at least equal to the withdrawal amount are made to a 529 plan for the same beneficiary within 60 days. A trustee-to-trustee transfer is another option. This may be a good idea when the Coverdell beneficiary is nearing the Coverdell required distribution age of 30 and you want to keep the funds invested on a tax-deferred basis. (Most 529 plans have no age limits.) It could also make sense when a Coverdell ESA investor has an opportunity to capture some state-specific benefits in a 529 plan, such as state income tax deduction on contributions.
- From an Education Savings Bond to a 529 plan. U.S. savings bonds may be redeemed tax-free when certain conditions are met. The bond must be a Series EE bond issued after 1989, or a Series I Bond, purchased and owned by an individual at least 24 years old before the month of purchase. In addition, the bondholder must have modified adjusted gross income below an income phase-out in the year of redemption and the bondholder, the bondholder’s spouse or the bondholder’s dependent must incur qualified higher education expenses at least equal to the amount of bond redemption proceeds. A contribution to a 529 plan is considered a “qualified” expense when redeeming a bond, even when the beneficiary has not yet reached college age. Consider making this move if you expect your income to be beyond the phase-out by the time college rolls around, but find that you’re within the income limits in the current year.
- From one 529 plan to another 529 plan. The law permits federal tax-free rollovers between 529 plans. Simply withdraw from your current 529 plan and within 60 days contribute the funds into another 529 plan for the same beneficiary, or for another beneficiary who qualifies as a family member of the first beneficiary. You must be careful here. You are limited to one same-beneficiary rollover in any 12-month period. You may want to switch the beneficiary to a sibling as part of the rollover process just to avoid any possible problems.
- From a 529 plan to an ABLE account. You can transfer up to the annual gift tax exclusion amount each year from a 529 plan to a 529A ABLE account for a disabled child. The amount you can transfer is reduced by the amount of other contributions to the ABLE account. The ability to make tax-free transfers was added by the Tax Cuts and Jobs Act of 2017 and applies to tax years from 2018 through 2025, inclusive. One reason to keep the money in a 529 plan and transfer the funds to an ABLE account, as needed, is to avoid the asset forfeiture clause in ABLE accounts.
[Editor’s note: This article was originally published on January 27, 2004 and updated on October 20, 2020 by Mark Kantrowitz.]