Planning for Healthcare Costs in Retirement: Why Medicare Isn’t Enough

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

When most people picture retirement, they imagine travel, hobbies, and more free time—not skyrocketing healthcare bills. Yet, one of the biggest financial surprises retirees face is how much they’ll actually spend on medical expenses.

Many retirees dramatically underestimate their healthcare costs in retirement, even though this is the stage of life when most people access the healthcare system the most. While it’s common to pay off your mortgage leading up to retirement, it’s not uncommon for healthcare costs to replace your mortgage payment in retirement.

In this article, we’ll cover:

• Why Medicare isn’t free—and what parts you’ll still need to pay for.

• What to consider if you retire before age 65 and don’t yet qualify for Medicare.

• The difference between Medicare Advantage and Medicare Supplement plans.

• How prescription drug costs can take retirees by surprise.

• The reality of long-term care expenses and how to plan for them.

Planning for Healthcare Before Age 65

For those who plan to retire before age 65, healthcare planning becomes significantly more complicated—and expensive. Since Medicare doesn’t begin until age 65, retirees need to bridge the coverage gap between when they stop working and when Medicare starts.

If your former employer offers retiree health coverage, that’s a tremendous benefit. However, it’s critical to understand exactly what that coverage includes:

• Does it cover just the employee, or both the employee and their spouse?

• What portion of the premium does the employer pay, and how much is the retiree responsible for?

• What out-of-pocket costs (deductibles, copays, coinsurance) remain?

If you don’t have retiree health coverage, you’ll need to explore other options:

• COBRA coverage through your former employer can extend your workplace insurance for up to 18 months, but it’s often very expensive since you’re paying the full premium plus administrative fees.

• ACA marketplace plans (available through your state’s health insurance exchange) may be an alternative, but premiums and deductibles can vary widely depending on your age, income, and coverage level.

In many cases, healthcare costs for retirees under 65 can be substantially higher than both Medicare premiums and the coverage they had while working. This makes it especially important to build early healthcare costs into your retirement budget if you plan to leave the workforce before age 65.

Medicare Is Not Free

At age 65, most retirees become eligible for Medicare, which provides a valuable foundation of healthcare coverage. But it’s a common misconception that Medicare is free—it’s not.

Here’s how it breaks down:

• Part A (Hospital Insurance): Usually free if you’ve paid into Social Security for at least 10 years.

• Part B (Medical Insurance): Covers doctor visits, outpatient care, and other services—but it has a monthly premium based on your income.

• Part D (Prescription Drug Coverage): Also carries a monthly premium that varies by plan and income level.

Example:

Let’s say you and your spouse both enroll in Medicare at 65 and each qualify for the base Part B and Part D premiums.

• In 2025, the standard Part B premium is approximately $185 per month per person.

• A basic Part D plan might average around $36 per month per person.

Together, that’s about $220 per person, or $440 per month for a couple—just for basic Medicare coverage. And this doesn’t include supplemental or out-of-pocket costs for things Medicare doesn’t cover.

NOTE: Some public sector or state plans even provide Medicare Part B premium reimbursement once you reach 65—a feature that can be extremely valuable in retirement.

Medicare Advantage and Medicare Supplement Plans

While Medicare provides essential coverage, it doesn’t cover everything. Most retirees need to choose between two main options to fill in the gaps:

• Medicare Advantage (Part C) plans, offered by private insurers, bundle Parts A, B, and often D into one plan. These plans usually have lower premiums but can come with higher out-of-pocket costs and limited provider networks.

• Medicare Supplement (Medigap) plans, which work alongside traditional Medicare, help pay for deductibles, copayments, and coinsurance.

It’s important not to simply choose the lowest-cost plan. A retiree’s prescription needs, frequency of care, and preferred doctors should all factor into the decision. Choosing the cheapest plan could lead to much higher out-of-pocket expenses in the long run if the plan doesn’t align with your actual healthcare needs.

Prescription Drug Costs: A Hidden Retirement Expense

Prescription drug coverage is one of the biggest cost surprises for retirees. Even with Medicare Part D, out-of-pocket expenses can add up quickly depending on the medications you need.

Medicare Part D plans categorize drugs into tiers:

• Tier 1: Generic drugs (lowest cost)

• Tier 2: Preferred brand-name drugs (moderate cost)

• Tier 3: Specialty drugs (highest cost, often with no generic alternatives)

If you’re prescribed specialty or non-generic medications, you could spend hundreds—or even thousands—per month despite having coverage.

To help, some states offer programs to reduce these costs. For example, New York’s EPIC program helps qualifying seniors pay for prescription drugs by supplementing their Medicare Part D coverage. It’s worth checking if your state offers a similar benefit.

Planning for Long-Term Care

One of the most misunderstood aspects of Medicare is long-term care coverage—or rather, the lack of it.

Medicare only covers a limited number of days in a skilled nursing facility following a hospital stay. Beyond that, the costs become the retiree’s responsibility. Considering that long-term care can easily exceed $120,000 per year, this can be a major financial burden.

Planning ahead is essential. Options include:

• Purchasing a long-term care insurance policy to offset future costs.

• Self-insuring, by setting aside savings or investments for potential care needs.

• Planning to qualify for Medicaid through strategic trust planning

Whichever route you choose, addressing long-term care early is key to protecting both your assets and your peace of mind.

Final Thoughts

Healthcare is one of the largest—and most underestimated—expenses in retirement. While Medicare provides a foundation, retirees need to plan for premiums, prescription costs, supplemental coverage, and potential long-term care needs.

If you plan to retire before 65, early planning becomes even more critical to bridge the gap until Medicare begins. By taking the time to understand your options and budget accordingly, you can enter retirement with confidence—knowing that your healthcare needs and your financial future are both protected.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQ)

Why isn’t Medicare enough to cover all healthcare costs in retirement?
While Medicare provides a solid foundation of coverage starting at age 65, it doesn’t pay for everything. Retirees are still responsible for premiums, deductibles, copays, prescription drugs, and long-term care—expenses that can add up significantly over time.

What should I do for healthcare coverage if I retire before age 65?
If you retire before Medicare eligibility, you’ll need to bridge the gap with options like COBRA, ACA marketplace plans, or employer-sponsored retiree coverage. These plans can be costly, so it’s important to factor early healthcare premiums and out-of-pocket expenses into your retirement budget.

What are the key differences between Medicare Advantage and Medicare Supplement plans?
Medicare Advantage (Part C) plans combine Parts A, B, and often D, offering convenience but limited provider networks. Medicare Supplement (Medigap) plans work alongside traditional Medicare to reduce out-of-pocket costs. The right choice depends on your budget, health needs, and preferred doctors.

How much should retirees expect to pay for Medicare premiums?
In 2025, the standard Medicare Part B premium is around $185 per month, while a basic Part D plan averages about $36 monthly. For a married couple, that’s roughly $440 per month for both—before adding supplemental coverage or out-of-pocket expenses. These costs should be built into your retirement spending plan.

Why are prescription drugs such a major expense in retirement?
Even with Medicare Part D, out-of-pocket drug costs can vary widely based on your prescriptions. Specialty and brand-name medications often carry high copays. Programs like New York’s EPIC can help eligible seniors manage these costs by supplementing Medicare coverage.

Does Medicare cover long-term care expenses?
Medicare only covers limited skilled nursing care following a hospital stay and does not pay for most long-term care needs. Since extended care can exceed $120,000 per year, retirees should explore options like long-term care insurance, Medicaid planning, or setting aside savings to self-insure.

How can a financial advisor help plan for healthcare costs in retirement?
A financial advisor can estimate future healthcare expenses, evaluate Medicare and supplemental plan options, and build these costs into your retirement income plan. At Greenbush Financial Group, we help retirees design strategies that balance healthcare needs with long-term financial goals.

Special Tax Considerations in Retirement

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

You might think that once you stop working, your tax situation becomes simpler — after all, no more paychecks! But for many retirees, taxes actually become more complex. That’s because retirement often comes with multiple income sources — Social Security, pensions, pre-tax retirement accounts, brokerage accounts, cash, and more.

At the same time, retirement can present unique tax-planning opportunities. Once the paychecks stop, retirees often have more control over which tax bracket they fall into by strategically deciding which accounts to pull income from.

In this article, we’ll cover:

• How Social Security benefits are taxed

• Pension income rules (and how they vary by state)

• Taxation of pre-tax retirement accounts like IRAs and 401(k)s

• Developing an efficient distribution strategy

• Special tax deductions and tax credits for retirees

• Required Minimum Distribution (RMD) planning

• Charitable giving strategies, including QCDs and donor-advised funds

How Social Security Is Taxed

Social Security benefits may be tax-free, partially taxed, or mostly taxed — depending on your provisional income. Provisional income is calculated as:

Adjusted Gross Income (AGI) + Nontaxable Interest + ½ of Your Social Security Benefits.

Here’s a quick summary of how benefits are taxed at the federal level:

While Social Security is taxed at the federal level, most states do not tax these benefits. However, a handful of states — including Colorado, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, and Vermont — do impose some form of state tax on Social Security income.

Pension Income

If you’re fortunate to receive a state pension, your state of residence plays a big role in determining how that income is taxed.

• If you have a state pension and continue living in the same state where you earned the pension, many states exclude that income from state tax.

• However, with state pensions, if you move to another state, and that state has income taxation at the stateve level, your pension may become taxable in your new state of domicile.

• If you have a pension with a private sector employer, often times those pension payment are full taxable at both the federal and state level.

Some states also provide preferential treatment for private pensions or IRA income. For example, New York excludes up to $20,000 per person in pension or IRA distributions from state income tax each year — a significant benefit for retirees managing taxable income.

Taxation of Pre-Tax Retirement Accounts

Pre-tax retirement accounts — including Traditional IRAs, 401(k)s, 403(b)s, and inherited IRAs — are typically taxed as ordinary income when distributions are made.

However, the tax treatment at the state level varies:

• Some states (like New York) exclude a set amount – for example New York excludes the first $20,000 per person per year — from state taxation.

• Others tax all pre-tax distributions in full.

• A few states offer income-based exemptions or reduced rates for lower-income retirees.

Because these rules differ so widely, it’s important to research your state’s tax laws.

Developing a Tax-Efficient Distribution Strategy

A well-designed distribution strategy can make a big difference in how much tax you pay throughout retirement.

Many retirees have income spread across:

• Pre-tax accounts (401(k), IRA)

• After-tax brokerage accounts

• Roth IRAs

• Social Security

Let’s say you need $70,000 per year to maintain your lifestyle. Some of that may come from Social Security, but you’ll need to decide where to withdraw the rest.

With smart planning, you can blend withdrawals from different accounts to minimize your overall tax liability and control your tax bracket year by year. The goal isn’t just to reduce taxes today — it’s to manage them over your lifetime.

Special Deductions and Credits in Retirement

Your Adjusted Gross Income (AGI) or Modified AGI doesn’t just determine your tax bracket — it also affects which deductions and credits you can claim.

A few important highlights:

• The Big Beautiful Tax Bill that just passed in 2025 introduces a new Age 65+ tax deduction of $6,000 per person over and above the existing standard deduction.

• Certain deductions and credits, however, phase out once income exceeds specific thresholds.

• Your income level also affects Medicare premiums for Parts B and D, which increase if your income surpasses the IRMAA thresholds (Income-Related Monthly Adjustment Amount).

Managing your taxable income through careful distribution planning can therefore help preserve deductions and keep Medicare premiums lower.

Required Minimum Distribution (RMD) Planning

Once you reach age 73 or 75 (depending on your birth year), you must begin taking Required Minimum Distributions (RMDs) from your pre-tax retirement accounts — even if you don’t need the money.

These RMDs can significantly increase your taxable income, especially when stacked on top of Social Security and other income sources.

A proactive strategy is to take controlled distributions or perform Roth conversions before RMD age. Doing so can reduce the size of your future RMDs and potentially lower your lifetime tax bill by spreading taxable income across more favorable tax years.

Charitable Giving Strategies

Many retirees are charitably inclined, but since most take the standard deduction, they don’t receive an additional tax benefit for their donations.

There are two primary strategies to consider:

1. Donor-Advised Funds (DAFs) – You can “bunch” several years’ worth of charitable giving into one tax year to exceed the standard deduction, then direct the funds to charities over time.

2. Qualified Charitable Distributions (QCDs) – Once you reach age 70½, you can donate directly from your IRA to a qualified charity. These QCDs are excluded from taxable income and count toward your RMD once those begin.

Final Thoughts

Retirement opens up new opportunities — and new complexities — when it comes to managing taxes. Understanding how your various income sources interact and planning your distributions strategically can help you:

• Reduce taxes over your lifetime

• Preserve more of your retirement income

• Maintain flexibility and control over your financial future

As always, it’s wise to coordinate with a financial advisor and tax professional to ensure your retirement tax strategy aligns with your goals, income sources, and state tax rules.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQ)

How are Social Security benefits taxed in retirement?
Depending on your provisional income, up to 85% of your Social Security benefits may be subject to federal income tax. Most states don’t tax these benefits, though a few—including Colorado, Minnesota, and Utah—do.

How is pension income taxed, and does it vary by state?
Pension income is typically taxable at the federal level, but state rules differ. Some states exclude public pensions from taxation or offer partial exemptions—like New York’s $20,000 per person exclusion for pension or IRA income. If you move to another state in retirement, your pension’s tax treatment could change.

What taxes apply to withdrawals from pre-tax retirement accounts?
Distributions from Traditional IRAs, 401(k)s, and similar pre-tax accounts are taxed as ordinary income. Some states offer exclusions or partial deductions, while others tax these withdrawals in full. Understanding your state’s rules is essential for accurate tax planning.

What is a tax-efficient withdrawal strategy in retirement?
A tax-efficient strategy blends withdrawals from different account types—pre-tax, Roth, and after-tax—to control your annual tax bracket. The goal is not just to lower taxes today but to reduce lifetime taxes by managing income across multiple years and minimizing required minimum distributions later.

What new tax deductions or credits are available for retirees?
The 2025 tax law introduced an additional $6,000 deduction per person age 65 and older, in addition to the standard deduction. Keeping taxable income lower through smart planning can also help retirees preserve deductions and avoid higher Medicare IRMAA surcharges.

How do Required Minimum Distributions (RMDs) impact taxes?
Starting at age 73 or 75 (depending on birth year), retirees must withdraw minimum amounts from pre-tax retirement accounts, which increases taxable income. Performing partial Roth conversions or strategic withdrawals before RMD age can help reduce future tax exposure.

What are Qualified Charitable Distributions (QCDs) and how do they work?
QCDs allow individuals age 70½ or older to donate directly from an IRA to a qualified charity, satisfying all or part of their RMD while excluding the amount from taxable income. This strategy helps maximize charitable impact while reducing taxes in retirement.

How To Protect A Roth IRA from the Medicaid Spenddown Process

Individuals often use Irrevocable Trusts or Medicaid Trusts to protect assets from future long-term care events. However, it’s historically been challenging to protect Roth IRAs from the Medicaid spenddown process due to the fact that:

1. Roth IRAs cannot be owned by a trust

2. Roth IRAs do not have an RMD requirement

It’s especially problematic with the rise in popularity of processing Roth Conversions in retirement to take advantage of lower tax rates, reduce future RMDs, and pass more Roth dollars onto the next generation, which is arguably the most valuable type of asset to inherit. Not only are Roth IRAs inherited tax free, but the beneficiary can earn investment returns within that Inherited Roth IRA for another 10 years before receiving the full account balance tax free.

Things have also gotten better for residents of New York with Roth IRAs because the full balance of a Roth IRA may no longer be subject to the Medicaid spenddown process, thanks to a new strategy from our friends in the trust and estate arena.

A Trust Cannot Own Roth IRAs

While trusts can be set up to own brokerage accounts, real estate, and checking accounts, one of the long-standing challenges associated with protecting a Roth IRA is that an individual cannot transfer ownership of an IRA to a trust.  This obstacle has not changed, but another workaround to this limitation has surfaced.

No RMD Requirement for Roth IRAs

One of the advantages of a Roth IRA over a Traditional IRA is that a Roth IRA does not have a Required Minimum Distribution (RMD) requirement.  For traditional IRAs and other pre-tax retirement accounts, individuals born after 1960 are required by the IRS to begin RMDs at age 75 and continue them annually thereafter. This is a way for the IRS to collect some income tax on all the tax-deferred balances in these pre-tax retirement accounts.

Roth IRAs do not have an RMD requirement, which is viewed as an advantage, except when it comes to a long-term care event and the Medicaid spenddown process.

When an individual experiences a long-term care event, Medicaid tallies up all of that individual’s “countable assets” to determine how much needs to be spent on their care before Medicaid will start picking up the tab.  Traditional IRAs are not considered a “countable asset,” but the annual required minimum distributions (RMDs) from traditional IRAs are considered income that must be applied to that individual's cost of care. 

For example, Jim has a $300,000 brokerage account and a $800,000 traditional IRA.  He sets up an Irrevocable Trust to own his brokerage account, makes it past the 5-year look-back period, and then has a long-term care event at age 83 that requires him to enter a nursing home.  The brokerage account is completely protected, not subject to spending down. However, the Traditional IRA has a $800,000 balance, still owned by Jim, and he is receiving a $45,000 per year RMD.  Instead of Jim having to spend down the entire IRA account, he just needs to commit the $45,000 RMD towards his care, and Medicaid will cover the remaining expenses. Using this strategy, Jim has been able to preserve both his $300,000 brokerage account and his $800,000 Traditional IRA, less the annual required minimum distributions (RMDs), for his children.

Roth IRA Voluntary RMD

Historically, Roth IRAs have been considered a “countable asset” for purposes of the Medicaid spenddown process in New York because there is no RMD requirement to covert that countable asset into an income stream. Recently, however, professionals in the trust and estate arena have successfully protected Roth IRAs from the Medicaid spenddown process by voluntarily turning on RMD distributions from the Roth IRA account, even though RMDs are not required from Roth IRAs, and Medicaid has accepted this approach.

For example, Sarah has a $300,000 Roth IRA that would normally be subject to the Medicaid spenddown process. Sarah has a long-term care event, and her power of attorney contacts the custodian of the Roth IRA and instructs them to begin annual distributions from the Roth IRA based on the IRS RMD table.  The voluntary Roth RMD amount will be counted toward Sarah’s income threshold for purposes of Medicaid and eventually applied towards the cost of her care. Now that Sarah has converted the Roth IRA to a retirement income stream, Medicaid no longer requires Sarah to fully spend down the balance in the Roth IRA before submitting her Medicaid application.

Disclosure: I am a Certified Financial Planner, not a trust and estate attorney.  The information in this article was obtained through firsthand experience consulting with trust and estate attorneys in New York, as well as with clients who have undergone the Medicaid application process.   For legal advice, please consult an attorney.  Additionally, note that Medicaid rules vary from state to state.  If you live outside of New York, the Medicaid rules in your state may vary from the rules covered in this article, which are specific to New York.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

Why are Roth IRAs difficult to protect from Medicaid spenddown?
Roth IRAs traditionally pose a challenge in Medicaid planning because they cannot be owned by a trust and have no Required Minimum Distribution (RMD) requirement. Without mandatory distributions converting the account into income, Medicaid typically treats the full Roth IRA balance as a “countable asset,” subject to spenddown before benefits begin.

Can a trust own a Roth IRA?
No. Federal tax law prohibits transferring ownership of an IRA—Roth or traditional—to a trust during the owner’s lifetime. This limitation prevents direct trust ownership of Roth IRAs as a Medicaid protection strategy.

Why don’t Roth IRAs have RMDs, and why does that matter for Medicaid?
Roth IRAs are not subject to RMDs during the account owner’s lifetime, which is normally an advantage for tax planning and estate growth. However, for Medicaid purposes, this lack of required distributions means the full account balance is considered a countable asset, unlike traditional IRAs, where only annual RMD income is counted.

What is the new “voluntary RMD” strategy for Roth IRAs in New York?
In New York, some estate attorneys have successfully used a new strategy that involves voluntarily initiating RMD-style distributions from a Roth IRA. By doing this, the Roth IRA produces income that Medicaid counts toward the individual’s care costs. In turn, the principal balance of the Roth IRA is no longer treated as a spendable asset.

How does the voluntary RMD approach work?
The power of attorney or account owner instructs the Roth IRA custodian to calculate and distribute annual withdrawals using the IRS RMD life expectancy table. Medicaid recognizes these withdrawals as income, allowing the Roth IRA itself to remain intact.

Does this strategy apply outside of New York?
Medicaid rules vary by state. The voluntary RMD approach has been accepted in New York, but other states may treat Roth IRAs differently. It’s important to consult a local elder law or trust and estate attorney before implementing this strategy.

Why would someone want to preserve a Roth IRA from Medicaid spenddown?
Roth IRAs are among the most valuable assets to pass to heirs because they grow tax-free and can continue to accumulate returns for up to 10 years after inheritance. Protecting Roth balances from Medicaid spenddown helps preserve this tax-free wealth for the next generation.

Should I speak to an attorney before using this strategy?
Yes. While financial planners can coordinate Medicaid and investment strategies, only a qualified trust and estate attorney can provide legal advice specific to Medicaid eligibility and trust structures.

529 to Roth IRA Transfers: A New Backdoor Roth Contribution Strategy Is Born

With the passing of the Secure Act 2.0, starting in 2024, owners of 529 accounts will now have the ability to transfer up to $35,000 from their 529 college savings account directly to a Roth IRA for the beneficiary of the account.  While on the surface, this would just seem like a fantastic new option for parents that have money leftover in 529 accounts for their children, it is potentially much more than that.  In creating this new rule, the IRS may have inadvertently opened up a new way for high-income earners to move up to $35,000 into a Roth IRA, creating a new “backdoor Roth IRA contribution” strategy for high-income earners and their family members. 

Money Remaining In the 529 Account for Your Children

I will start by explaining this new 529 to Roth IRA transfer provision using the scenario that it was probably intended for; a parent that owns a 529 account for their children, the kids are done with college, and there is still a balance remaining in the 529 account.

The ability to shift money from a 529 account directly to a Roth IRA for your child is a fantastic new distribution option for balances that may be leftover in these accounts after your child or grandchild has completed college.   Prior to the passage of the Secure Act 2.0, there were only two options for balances remaining in 529 accounts:

1. Change the beneficiary on the account to someone else

2. Process a non-qualified distribution from the account

Both options created potential challenges for the owners of 529 accounts.  For the “change the beneficiary option”, what if you only have one child, or what if the remaining balance is in the youngest child’s account? There may not be anyone else to change the beneficiary to. 

The second option, processing a “non-qualified distribution” from the 529 account, if there were investment earnings in the account, those investment earnings are subject to taxes and a 10% penalty because they were not used to pay a qualified education expense.

The “Roth Transfer Option” not only gives account owners a third attractive option, but it’s so attractive that planners may begin advising clients to purposefully overfund these 529 accounts with the intention of processing these Roth transfers after the child has completed college.

Requirements for 529 to Roth IRA Transfers

Before I get into explaining the advanced tax and wealth accumulation strategies associated with this new 529 distribution option, like any new tax law, there is a list of rules that you have to follow to be eligible to process these 529 to Roth IRA transfers.

The 15 Year Rule

The first requirement is the 529 account must have been in existence for at least 15 years to be eligible to execute a Roth transfer from the account.  The clock starts when you deposit the first dollar into that 529 account.  The planning tip here is to fund the 529 as soon as you can after the child is born, if you do, the 529 account will be eligible for Roth IRA transfers by their 15th or 16th birthday.

There is an unanswered question surrounding rollovers between state plans and this 15-year rule.  Right now, you are allowed to rollover let’s say a Virginia 529 account into a New York 529 account.  The question becomes, since the New York 529 account is a new account, would that end up re-setting the 15-year inception clock?

Contributions Within The Last 5 Years Are Not Eligible

When you go to process a Roth transfer from a 529 account, contributions made to the 529 account within the previous 5 years are not eligible for Roth transfers. 

The Beneficiary of the 529 Account and the Owners of the Roth IRA Must Be The Same Person

A third requirement is the beneficiary listed on the 529 account and the owner of the Roth IRA account must be the same person.   If your daughter is the beneficiary of the 529 account, she would also need to be the owner of the Roth IRA that is receiving the transfer directly from the 529 account.  There is a big question surrounding this requirement that we still need clarification on from the IRS.  The question is this: Is the account owner allowed to change the beneficiary on the 529 account without having to re-satisfy a new 15-year account inception requirement? 

If they allow beneficiary changes without a new 15-year inception period, with 529 accounts, the account owner can change the beneficiary on these accounts to whomever they want……..including themselves.  This would allow a parent to change the beneficiary to themselves on the 529 account and then transfer the balance to their own Roth IRA, which may not be the intent of the new law. We will have to wait for guidance on this.

No Roth IRA Income Limitations

As many people are aware, if you make too much, you are not allowed to contribute to a Roth IRA.  For 2023, the ability to make Roth IRA contributions begins to phase out at the following income levels:

Single Filer:  $138,000

Married Filer: $218,000

These transfers directly from 529 accounts to the beneficiary’s Roth IRA do not carry the income limitation, so regardless of the income level of the 529 account owner or the beneficiary, there a no maximum income limit that would preclude these 529 to Roth IRA transfers from taking place.

The IRA Owner Must Have Earned Income

With exception of the Roth IRA income phaseout rules, the rest of the Roth RIA rules still apply when determining whether or not a 529 to Roth IRA transfer is allowed in a given tax year.  First, the beneficiary of the 529 (also the owner of the Roth IRA) needs to have earned income in the year that the transfer takes place to be eligible to process a transfer from the 529 to their Roth IRA.  

Annual 529 to Roth IRA Transfer Limits

The amount that can be transferred from the 529 to the Roth IRA is also limited each year by the regular Roth IRA annual contribution limits.  For 2023, an individual under the age of 50, is allowed to make a Roth IRA contribution of up to $6,500.   That is the most that can be moved from the 529 account to Roth IRA in a single tax year.  But in addition to this hard dollar limit, you have to also take into account any other Roth IRA contributions that were made to the IRA owner’s account and the IRA owners earned income for that tax year.

The annual contribution limit to a Roth IRA for 2023 is actually the LESSER of:

• $6,500; or

• 100% of the earned income of the account owner

Assuming the IRA contribution limits stay the same in 2024, if a child only has $3,000 in income, the maximum amount that could be transferred from the 529 to the Roth IRA in 2024 is $3,000.

If the child made a contribution of their own to the Roth IRA, that would also count against the amount that is available for the 529 to Roth IRA transfer.  For example, the child makes $10,000 in earned income, making them eligible for the full $6,500 Roth IRA contribution, but if the child contributes $2,000 to their Roth IRA throughout the year, the maximum 529 to Roth IRA transfer would be $4,500 ($6,500 - $2,000 = $4,500)

The IRA limits could be the same or potentially higher in 2024 when this 529 to Roth IRA transfer option goes into effect.

$35,000 Limiting Maximum Per Beneficiary

The maximum lifetime amount that can be transferred from a 529 to a Roth IRA is $35,000 for each beneficiary.  Given the annual contribution limits that we just covered, you would not be allowed to just transfer $35,000 from the 529 to the Roth IRA all in one shot.  The $35,000 lifetime limit would be reached after making multiple years of transfers from the 529 to the Roth IRA over a number of tax years.

Advanced 529 Planning Strategies Using Roth Transfers

Now I’m going to cover some of the advanced tax and wealth accumulation strategies that may be able to be executed under this 529 Roth Transfer provision.  Disclosure, writing this in February 2023, we are still waiting on guidance from the IRS on what they may or may not have intended with this new 529 to Roth transfer option that becomes available starting in 2024, so their guidance could either reinforce that these strategies can be used or limit the use of these advanced strategies. Time will tell.

Super Funding A Roth IRA For Your Child

While 529 accounts have traditionally been used to save exclusively for future college expenses for your children or grandchild, they just become much more than that.   Parents and grandparents can now fund these accounts when a child is young with the pure intention of NOT using the funds for college but rather creating a supercharged Roth IRA as soon as that child begins earning income in their teenage years and into their 20s. 

This is best illustrated in an example.  You have a granddaughter that is born in 2023, you open a 529 account for her and fund it with $15,000.  By the time your granddaughter has reached age 18, let’s assume through wise investment decisions, the account has tripled to $45,000.  Between ages 18 and 21, she works a summer job making $8,000 in earned income each year and then gets a job after graduating college making $80,000 per year.  Assuming she made no contributions to a Roth IRA over the years, you would be able to make transfers between her 529 account and her Roth IRA up to the annual contribution limit until the total transfers reached the $35,000 lifetime maximum. 

If that $35,000 lifetime maximum is reached when she turns age 24, assuming she also makes wise investment decisions and earns 8% per year on her Roth IRA until she reaches age 60, at age 60 she would have $620,000 in that Roth IRA account that could be withdrawal ALL TAX-FREE. 

Now multiply that $620,000 across EACH of your children or grandchildren, and it becomes a truly fantastic way to build tax-free wealth for the next generation.

529 Backdoor Roth Contribution Strategy

A fun fact, there are no age limits on either the owner or beneficiary of a 529 account.  At the age of 40, I could open a 529 account, be the owner and the beneficiary of the account, fund the account with $15,000, wait the 15 years, and then when I turn age 55, begin processing transfers directly from the 529 to my Roth IRA up to the maximum annual IRA limit each year until I reach my $35,000 lifetime limit. 

I really don’t care that the money has to sit in the 529 for 15 years because 529 accumulate tax deferred anyways, and by the time I hit age 59.5, making me eligible for tax-free withdrawal of the earnings, I will have already moved most of the balance over to my Roth IRA. Oh and remember, even if you make too much to contribute directly to a Roth IRA, the income limits do not apply to these 529 to Roth IRA direct transfers.

The IRS may have inadvertently created a new “Backdoor Roth IRA Contribution” strategy for high-income earners.  

Now there may be some limitations that can come into play with the age of the individual executing this strategy, it’s really less about their age, and more about whether or not they will have earned income 15 years from now when the 529 to Roth IRA transfer window opens.  If you are 65, fund a 529, and then at age 80 want to begin these 529 to Roth IRA transfers, if you have no earned income, you can process these 529 to Roth IRA transfers because you are limited by the regular IRA annual contribution limits that require you to have earned income to process the transfers.

Advantage Over Traditional Backdoor Roth Conversions

For individuals that have a solid understanding of how the traditional “Backdoor Roth IRA Contribution” strategy works, the new 529 to Roth IRA transfer strategy potentially contains additional advantages over and above the traditional backdoor Roth strategy. These movements from the 529 to Roth IRA are not considered “conversions”, they are considered direct transfers. Why is that important? Under the traditional Backdoor Roth Contribution strategy the taxpayer is making a non-deductible contribution to a traditional IRA and then processes a conversion to a Roth IRA. 

One of the IRS rules during this conversion process is the “aggregation rule”.  When a Roth conversion is processed, the taxpayer has to aggregate all of their pre-tax IRA balance together in determining how much of the conversion is taxable, so if the taxpayer has other pre-tax IRAs, it came sometimes derail the backdoor Roth contribution strategy.  If they instead use the 529 to Roth IRA direct transfer processes, since as of right now it is not technically a “conversion”, the aggregate rule is avoided.

The second big advantage is with the 529 to Roth IRA transfer strategy, the Roth IRA is potentially being funded with “untaxed earnings” as opposed to after-tax dollar. Again, in the traditional Backdoor Roth Strategy, the taxpayer is using after-tax money to make a nondeductible contribution to a Traditional IRA and then converting those dollars to a Roth IRA. If instead the taxpayer funds a 529 with $15,000 in after-tax dollars, but during the 15-year holding, The account grows the $35,000, they are then able to begin direct transfers from the 529 to the Roth IRA when $20,000 of that account balance represents earnings that were never taxed. Pretty cool!!

State Tax Deduction Clawbacks?

There are some states, like New York, that offer tax deductions for contributions to 529 accounts up to annual limits.  When the federal government changes the rules for 529 accounts, the states do not always follow suit.  For example, when the federal government changed the tax laws allowing account owners to distribute up to $10,000 per year for K – 12 qualified expenses from 529 accounts, some states, like New York, did not follow suit, and did not recognize the new “qualified expenses”.  Thus, if someone in New York distributed $10,000 from a 529 for K – 12 expenses, while they would not have to pay federal tax on the distribution, New York viewed it as a “non-qualified distribution”, not only making the earnings subject to state taxes but also requiring a clawback of any state tax deduction that was taken on the contribution amounts.   

The question becomes will the states recognize these 529 to Roth IRA transfers as “qualified distributions,” or will they be subject to taxes and deduction clawbacks at the state level? Time will tell.  

Waiting for Guidance From The IRS

This new 529 to Roth IRA transfer option that starts in 2024 has the potential to be a tremendous tax-free wealth accumulation strategy for not just children but for individuals of all ages. However, as I mentioned multiple times in the article, we have to wait for formal guidance from the IRS to determine which of these advanced wealth accumulation strategies will be allowed from tax years 2024 and beyond.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the new 529 to Roth IRA transfer rule under the Secure Act 2.0?
Starting in 2024, owners of 529 college savings accounts can transfer up to $35,000 over their lifetime from a 529 directly to a Roth IRA for the account’s beneficiary. This gives families a new tax-free way to repurpose unused education savings.

What are the main requirements for a 529 to Roth IRA transfer?
The 529 account must be at least 15 years old, and contributions made within the last 5 years cannot be transferred. The 529 beneficiary and the Roth IRA owner must be the same person, and the beneficiary must have earned income in the year of transfer.

How much can be transferred each year?
Transfers are subject to the annual Roth IRA contribution limit—currently $6,500 per year (or less if earned income is lower). It may take several years to reach the $35,000 lifetime transfer cap.

Do income limits apply to 529 to Roth IRA transfers?
No. These transfers are not subject to Roth IRA income phaseouts, meaning high-income earners can use this rule even if they’re normally ineligible to contribute directly to a Roth IRA.

Can parents use this rule as a backdoor Roth IRA strategy?
Potentially. If future IRS guidance allows changing a 529 beneficiary to oneself without restarting the 15-year clock, high-income earners could fund their own Roth IRAs using this method—creating a new type of “backdoor Roth” strategy.

Are there potential state tax implications?
Yes. Some states may not treat 529-to-Roth transfers as qualified distributions, which could trigger state taxes or clawbacks of prior state tax deductions.

When will the IRS provide more guidance on this rule?
The IRS is expected to issue clarifications before the rule takes effect in 2024. Guidance will determine whether advanced strategies—like beneficiary changes or state conformity—are allowed.

Removing Excess Contributions From A Roth IRA

You discovered that you contributed too much to your Roth IRA, now it’s time to fix it. This most commonly happens when individuals make more than they expected which causes them to phaseout of their ability to make a contribution to their Roth IRA for a particular tax year. In 2025, the phase out ranges for Roth IRA contributions are:

• Single Filer: $150,000 - $165,000

• Married Filing Joint:  $236,000 - $246,000

The good news is there are a few options available to you to fix the problem but it’s important to act quickly because as time passes, certain options for removing those excess IRA contributions will be eliminated.

You Discover The Error Before You File Your Taxes

If you discover the contribution error prior to filing your tax return, the most common fix is to withdraw the excess contribution amount plus EARNINGS by your tax filing deadline, April 18th.   Custodians typically have a special form for removing excess contributions from your Roth IRA that you will need to complete.

If you withdraw the excess contribution before the tax deadline, you will avoid having to pay the IRS 6% excise penalty on the contribution, but you will still have to pay income tax on the earnings generated by the excess contribution.  In addition, if you are under the age of 59½, you will also have to pay the 10% early withdrawal penalty on just the earnings portion of the excess contribution.

Example, you contribute $6,000 to your Roth IRA in September 2024 but you find out in March 2025 that your income level only allows you to make a $2,000 contribution to your Roth IRA for 2024 so you have a $4,000 excess contribution.  You will have to withdraw not just the $4,000 but also the earnings produced by the $4,000 while it was in the account, for purposes of this example let’s assume that’s $400.   The $4,000 is returned to you tax and penalty free but when the $400 in earnings is distributed from the account, you will have to pay tax on the earnings, and if under age 59½, a 10% withdrawal penalty on the $400.  

October 15th Deadline

If you have already filed your taxes and you discover that you have an excess contribution to a Roth IRA, but it’s still before October 15th, you can avoid having to pay the 6% penalty by filing an amended tax return.  You still have pay taxes and possibly the 10% early withdrawal penalty on the earnings but you avoid the 6% penalty on the excess contribution amount.   This is only available until October 15th following the tax year that the excess contribution was made.

You Discover The Mistake After The October 15th Extension Deadline

If you already filed your taxes and you did not file an amended tax return by October 15th, the IRS 6% excess contribution penalty applies.   If you contributed $6,000 to Roth IRA but your income precluded you from contributing anything to a Roth IRA in that tax year, it would result in a $360 (6%) penalty.  But it’s important to understand that this is not a one-time 6% penalty but rather a 6% PER YEAR penalty on the excess amount UNTIL the excess amount is withdrawn from the Roth IRA.  If you discovered that 5 years ago you made a $5,000 excess contribution to your Roth IRA but you never removed the excess contributions, it would result in a $1,500 penalty.  

6% x 5 Years = 30% Total Penalty x $5,000 Excess Contribution = $1,500 IRS Penalty

A 6% Penalty But No Earnings Refund

Here’s a little known fact about the IRS excess contribution rules, if you are subject to the 6% penalty because you did not withdraw the excess contributions out of your Roth IRA prior to the tax deadline, when you go to remove the excess contribution, you are no longer required to remove the earnings generated by the excess contribution. 

Reminder: If you remove the excess contribution prior to the initial tax deadline, you AVOID the 6% penalty on the excess contribution amount but you have to pay taxes and possibly the 10% early withdrawal penalty on just the earnings portion of the excess contribution. 

If you remove the excess contribution AFTER the tax deadline, you do not have to pay taxes or penalties on the EARNINGS portion because you are not required to distribute the earnings, but you pay a flat 6% penalty per year based on the actual excess contribution amount.

Example:  You contributed $6,000 to your Roth IRA in 2024, your income ended up being too high to allow any Roth IRA contributions in 2024, you discover this error in November 2025.  You will have to withdraw the $6,000 excess contribution, pay the 6% penalty of $360, but you do not have to distribute any of the earnings associated with the excess contribution.

Why does it work this way?  This is only a guess but since most taxpayers probably try to remove the excess contributions as soon as possible, maybe the 6% IRS penalty represents an assumed wipeout of a modest rate of return generated by those excess contributions while they were in the IRA.

Advanced Tax Strategy

There is an advanced tax strategy that involves evaluating the difference between the flat 6% penalty on the excess contribution amount and paying tax and possibly the 10% penalty on the earnings. Before I explain the strategy, I strongly advise that you consult with your tax advisor before executing this strategy.

I’ll show you how this works in an example.  You make a $6,000 contribution to your Roth IRA in 2024 but then find out in March 2025 that based on your income, you are not allowed to make a Roth contribution for 2024.  Your Roth IRA experienced a 50% investment return between the time you made the $6,000 contribution and now. You are 35 years old. So now you have a choice:

Option A: Prior to your 2024 tax filing, withdraw the $6,000 tax and penalty free, and also withdraw the $3,000 in earnings which will be subject to ordinary income tax and a 10% penalty. Assuming you are in a 32% Fed bracket, 6% State Bracket, that would cost you 48% in taxes and penalties on the $3,000 in earnings.

Total Taxes and Penalties = $1,440

Option B: Waiting until November 2025, pull out the $6,000 excess contribution, and pay the 6% penalty, but you get to leave the $3,000 in earnings in your Roth IRA.  $6,000 x 6% = $360

Total Taxes and Penalties = $360

PLUS you have an additional $3,000 that gets to stay in your Roth IRA, compound returns, and then be withdrawn tax and penalty free after age 59½. 

FINANCIAL NERD NOTE:  If the only balance in your Roth IRA is from earnings that originated from excess contributions, it’s does not start the 5-year holding period required to receive the Roth IRA earnings tax free after age 59½ because they are considered ineligible contributions retained within the Roth IRA. 

Losses Within The Roth IRA

Since I’m writing this in April 2024 and most of the equity indexes are down year-to-date, I’ll explain how losses within a Roth IRA impact the excess contribution calculation.  If your Roth IRA has lost value between the time you made the excess contribution and the withdrawal date, it does reduce the amount that you have to withdraw from the IRA.  If your excess contribution amount is $3,000 but the Roth IRA dropped 20% in value, you would only have to withdraw $2,400 from the Roth IRA to satisfy the removal of the excess contributions.  If withdrawn prior to your tax filing deadline, no taxes or penalties would be due because there were no earnings.

Other Options Besides Cash Withdrawals

Up until now we have just talked about withdrawing the excess contribution from your IRA by taking the cash back but there are a few other options that are available to satisfy the excess contribution rules. 

The first is “recharacterizing” your excess Roth contribution as a traditional IRA contribution. If your income allows, you may be able to transfer the excess Roth contribution amount and earnings from your Roth IRA to your Traditional IRA but this must be done in the same tax year to avoid the 6% penalty.

Second option, if you are eligible to make a Roth IRA contribution the following year, the excess contribution can be used to offset the Roth contribution amount for the following tax year. Example, if you had an excess Roth IRA contribution of $1,000 in 2024 and your income will allow you to make a $6,000 Roth IRA contribution in 2025, you can reduce the Roth contribution limit by $1,000 in 2025, leave the excess in the account, and just deposit the remaining $5,000.  You would still have to pay the 6% penalty on the $1,000 because you never withdrew it from the Roth IRA but it’s $60 penalty versus having to take the time to go through the excess withdrawal process.   

Which Contributions Get Pulled Out First

It’s not uncommon for investors to make monthly contributions to their Roth IRA accounts but when it comes to an excess contribution scenario, you don’t get to choose which contributions are entered into the earning calculation.   The IRS follows the LIFO (last-in-first-out) method for determining which contributions should be removed to satisfy the excess refund.  

You Have Multiple IRA’s

If you have multiple Roth IRA’s and there is an excess contribution, you have to remove the excess contribution from the same Roth IRA that the contribution was made to, you can’t take it from a different Roth IRA to satisfy the removal of the excess.  

If you have both a Traditional IRA and a Roth IRA and you exceed the aggregate contribution limit for the year, by default, the IRS assumes the excess contribution was made to the Roth IRA, so you have to begin taking corrective withdrawals from your Roth IRA first.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What happens if I contribute too much to my Roth IRA?
If your income is too high or you accidentally contribute more than the annual Roth IRA limit, the excess amount is considered an “excess contribution.” The IRS assesses a 6% penalty each year that the excess remains in the account until it’s corrected.

How can I fix a Roth IRA excess contribution before filing my taxes?
If you catch the mistake before your tax filing deadline (typically April 15), you can withdraw the excess contribution and any earnings. You’ll avoid the 6% penalty, but the earnings portion is taxable—and may be subject to a 10% early withdrawal penalty if you’re under age 59½.

What if I already filed my tax return but it’s before October 15?
You can file an amended return and withdraw the excess contribution plus earnings before October 15 to avoid the 6% excise tax. However, you’ll still owe income taxes and possibly the 10% early withdrawal penalty on the earnings portion.

What happens if I discover the excess contribution after October 15?
Once the October 15 deadline passes, you can no longer avoid the 6% annual penalty. The penalty continues each year until the excess amount is removed from your Roth IRA, but you no longer have to withdraw the earnings associated with that excess contribution.

Can I recharacterize or apply the excess contribution to a future year?
Yes. You can recharacterize the excess Roth contribution as a traditional IRA contribution, if eligible, by transferring it and any earnings. Alternatively, you can apply the excess toward next year’s contribution limit, but you’ll owe a 6% penalty for the current year.

What if my Roth IRA lost money after I made the excess contribution?
If the value of your Roth IRA declines, you only need to withdraw the reduced value of the excess contribution. For example, if your $3,000 excess contribution dropped 20% in value, you would only withdraw $2,400, and no taxes or penalties would apply if withdrawn before the filing deadline.

How does the IRS determine which contributions to remove?
The IRS uses a last-in, first-out (LIFO) method, meaning the most recent contributions are treated as the ones being withdrawn first. Excess withdrawals must come from the same Roth IRA where the contribution was made.