529 Rollover Rules

In September, a Savingforcollege.com survey found that 21 percent of families with 529 plans were unsatisfied and looking for a new plan. 

Due to the rising costs of college, it is crucial to find a plan that offers good investment options.  If a 529’s performance has been less than average, or the fees are not competitive with that of peer funds, consider rolling the account over to a new 529 plan. 

However, when it comes to switching plans, it is easy to get blind-sided.  Various rules and restrictions can cause the account owner to owe taxes and penalties that could have been avoided. 

Keep in mind a few important details when switching 529 plans.  First, when two plans are based in the same state, switching is an “investment change” and there are no tax penalties.  If you are switching from an in-state to an out-of-state plan, check your plan’s rules to see if you live in a state that requires “recapture” of any tax deductions that you took for your original in state plan.  Second, make sure to read the fine print, as some plans charge a processing fee for rollovers.  These costs can add up, and paying them may not be worth the switch.  Finally, ensure the transaction qualifies as a rollover rather than a distribution. Nonqualified distributions are liable for income taxes plus a 10 percent penalty on the earnings.

See Lindsay Gellman, How to Avoid Taxes, Penalties if Changing 529s, The Wall Street Journal, Nov. 9, 2014.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.