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Investing in 529 college savings plans have always been a risk. What if your kid doesn’t need all the money you saved? If their tuition is cheaper than expected, or they decide not to go to college at all, what happens to all the money tied up in your education-specific savings account?
Under current rules, leftover 529 funds must be used toward qualified education expenses or else be withdrawn and charged a 10% penalty and federal income tax on the earnings (not the contributions themselves). Next year, however, a new rule means any leftover college funds can indeed be rescued, penalty-free. Here’s what to know about an important rule change to 529 plans and how it impacts your savings for your kid.
The new 529 plan rule change
Starting in 2024, unused funds from a 529 plan can be rolled over into a Roth IRA for the account’s beneficiary without penalty. This new tax-free rollover rule—a part of part of SECURE 2.0—means you don’t have to worry about the current 10% penalty on the earnings if you end up with money left over. You will be able to rollover up to $35,000 from your 529 savings. Of course, the amount you can rollover is also subject to annual Roth IRA limits. (For reference, the contribution limit is $6,500 for 2023.)
USAToday ran some numbers to illustrate how impactful this rule change can be: “Assume you’ve rolled over the lifetime cap of $35,000 from the 529 into the Roth IRA by the time your kid graduates from college at age 22. By the time your kid reaches 67, retirement age, that amount will have grown to $1.6 million, based on 9% annual compound growth (the S&P 500 historically has returned around 10% each year).” That’s the magic of compound interest.
The fine print for this new rule
Now for the fine print: You must have owned the 529 educational savings account for at least 15 years before you can roll over the money, and you can only roll over money that’s been in the account for five or more years. And the account holder (usually a child’s parent or guardian) can’t roll over the money into their own Roth IRA—it must be an account established specifically for the beneficiary of the 529 plan.
Still, the removal of the 10% penalty means greater flexibility for 529 plans—and less fear that those funds will go to waste. The rule change should encourage parents to invest in 529 plans for their young children now, or perhaps to look more closely at their existing plans.
If you’re a parent and are looking to set up this college savings vehicle, start looking at online tools can help you compare different plan’s state-by-state offerings. Here’s our guide to opening a 529 for your kid.
