401(k) to 529 Rollover: What You Need to Know

Funds from an employee 401k plan can only be rolled over into one of two types of accounts without incurring costly tax penalties. Those two rollover options include transfer into a new 401k account with a new employer or deposit into an individual retirement account (IRA). There are no tax-deferred savings for using funds from a 401k toward furthering education or for education savings programs with tax benefits such as 529 plans.

Rollover Into a New 401k Account

When a 401k account holder leaves one employer to work for another, he typically is offered several options. He can withdraw the accumulated funds from a 401k plan, declare an account in which to rollover the funds or keep the funds in the current account. Employees going to work for a new employer that offers a 401k plan usually benefit by enrolling in the new plan and rolling over all accumulated funds from the old 401k into the new 401k.

Rollover Into an IRA

An IRA offers tax-deferred benefits similar to 401k programs. An employee who changes jobs often is not enrolled in a 401k plan long enough for deposited funds to prosper as the plan progresses. Consolidation of accounts is preferable to keeping multiple accounts with a string of former employers. The IRA offers a safe rollover vehicle for consolidating 401k funds without encountering any taxation for withdrawal or any tax penalties resulting from early withdrawal.

The 529 Account Management

A 529 account allows savings to be deposited for investment growth without taxation on accumulated interest. The funds also are tax-free when used to pay for any qualified costs of higher education. The available monies for various savings plans should be divided to include regular 529 deposits by anyone anticipating college costs. A 529 college fund need not be separated for individual children, and it can be used for adults in the family as well.

Paying Into a 529 Account From an IRA or a 401k

Payments into a 529 college fund account are not tax-free when made from an IRA, but early withdrawal penalties are waived for IRA funds when used for higher education of the account holder or his children or grandchildren. Funds from a 401k are not given any tax breaks when used for a 529 or for education. The 401k funds are best used by rolling them over into an IRA and paying for education costs directly.