Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / 529 Plans as a Down Payment Strategy for First-Time Home Buyers
Transcript
- Lucas: So there's a question I keep hearing from parents who've been diligent about funding a 529 plan—what happens if my kid doesn't use all the money for college? Could I use it for a down payment on their first home? Luna: I've heard that question too. Especially now that home prices have gone up so much in the last few years. Lucas: Right. And the short answer is: it's complicated. But there's a growing movement among states and at the federal level to allow exactly that. Let me walk through where things stand as of May 2026. Luna: Okay, let's start with the basics. Can you pull money out of a 529 for a down payment without paying a penalty? Lucas: Under current federal law, no. The qualified expenses for a 529 are tuition, room and board, fees, books, computers—and since the SECURE Act, up to ten thousand dollars in student loan repayment. A down payment is not on that list. Luna: So if you withdraw for a down payment, you'd owe income tax on the earnings plus a ten percent penalty. Lucas: Exactly. That's the default. But here's where it gets interesting: a few states have created their own exceptions. For example, Ohio and Pennsylvania now allow penalty-free withdrawals from their state-sponsored 529 plans specifically for first-time home purchases, up to certain limits. Luna: Wait—so state law can override the federal penalty? Lucas: Not exactly. The federal penalty still applies unless Congress changes the law. What states can do is waive their own state-level penalties and clawbacks of tax deductions. So if you live in Ohio and you took a state tax deduction for your 529 contributions, withdrawing for a home wouldn't trigger a state recapture. But the IRS still wants its ten percent. Luna: That's a meaningful distinction. So the state benefit is limited to the state tax side. Lucas: Right. And that's still valuable for families in high-tax states. But the bigger development is the SECURE 2.0 Act's Roth IRA rollover provision, which started in 2024. Luna: Oh, I remember that—you can roll over up to thirty-five thousand dollars from a 529 into a Roth IRA for the beneficiary, as long as the account has been open at least fifteen years. Lucas: Exactly. And that changes the calculus for the down payment strategy. Because once the money is in a Roth IRA, the owner can withdraw their contributions at any time penalty-free. And after five years, they can also withdraw up to ten thousand dollars for a first-time home purchase. Luna: So the path is: fund a 529, let it grow, roll the excess into a Roth IRA, then use Roth withdrawals for the down payment. Lucas: That's the playbook. But there are a lot of guardrails. First, the 529 has to be in the beneficiary's name—so if you're a parent saving for a child, the Roth IRA would be in the child's name, not yours. If they're responsible, it works. If they're not, you lose control. Luna: And the fifteen-year clock starts from when the 529 was opened, not when contributions were made. So if you opened the account when your kid was born, by age eighteen you've got eighteen years—that clears the hurdle. Lucas: Right. And the thirty-five-thousand-dollar lifetime cap on rollovers means you can't just put a huge 529 balance into a Roth in one shot. It's gradual, subject to annual Roth contribution limits. So this is more of a long-term strategy than a quick fix. Luna: If our money conversations have helped you think about a decision differently, I want to mention something. We deliberately keep this show ad-free so we can give you the straight story without any sponsors pushing a product. Lucas: Yeah, and that's a choice we feel strongly about. If you find that valuable and want to support it, there's a simple way. The link is buy me a coffee dot com slash fexingo. No obligation, just a way to keep this independent. Luna: It honestly makes a difference. So, back to the down payment angle—is there any pending legislation that would make a direct 529-to down payment transfer legal at the federal level? Lucas: There have been bills introduced in Congress—like the Helping Young Americans Save for Homeownership Act—that would add first-time home purchases to the list of qualified 529 expenses. But as of May 2026, none have passed. So for now, the Roth rollover path is the most viable federal option. Luna: Let's talk about the numbers. If a family saves fifty thousand dollars in a 529 over eighteen years and the child doesn't need it all for college, what's the realistic amount they could redirect to a home? Lucas: Assuming average market returns of say six to seven percent, that fifty thousand might grow to around one hundred and ten to one hundred twenty thousand. If the child uses, say, sixty thousand for college, that leaves fifty to sixty thousand. You can roll over thirty-five thousand into a Roth IRA—that's the cap—and then you'd have to withdraw the remaining fifteen to twenty-five thousand with the ten percent penalty. Luna: So after penalty and taxes on earnings, you might net maybe twelve to twenty thousand for the down payment from the excess, plus whatever you can pull from the Roth contributions. Lucas: Exactly. It's not a massive amount, but for a first-time buyer trying to scrape together three to five percent on a three-hundred-thousand-dollar home, that's ten to fifteen thousand. Every bit helps. Luna: What about the financial aid implications? If the 529 is counted as a parental asset, it's assessed at a maximum of five point six four percent for the FAFSA. But if you roll it into a Roth IRA in the child's name, does that change aid eligibility? Lucas: It could. Assets in the child's name are assessed at twenty percent for the FAFSA. So rolling into a Roth could actually hurt need-based aid if the child is still in school. You'd want to do the rollover after they've graduated or if they're not applying for aid. Luna: Good point. So timing matters a lot. If the child goes to trade school or an apprenticeship, they might use less than the full 529 balance, and you'd be rolling over sooner rather than later. Lucas: Right. And that's actually a growing scenario. Not everyone goes to a four-year university. For a child who does a two-year program or apprenticeship, the 529 can cover those costs, but the leftover might be substantial. The Roth rollover gives that money a second life. Luna: Let's say the child doesn't go to any postsecondary education. Can the parent just change the beneficiary to themselves and then use the 529 for their own Roth rollover? Lucas: The beneficiary can be changed to a family member, including the parent, for the purpose of the rollover. But the fifteen-year clock resets? Actually, no—the IRS clarified that the fifteen-year period is measured from the opening of the original account, not the change in beneficiary. So if you opened a 529 for your child eighteen years ago and they don't use it, you can change the beneficiary to yourself and then do a rollover into your own Roth IRA, subject to your own contribution limits. Luna: That's a powerful strategy for parents who have been saving a long time. They can effectively convert education savings into retirement savings. Lucas: And then use that retirement savings for a down payment if needed. The Roth IRA allows penalty-free withdrawals of contributions at any age, and up to ten thousand dollars of earnings for a first-time home purchase after five years. So it's a roundabout way, but it works. Luna: I want to zoom out for a second. Is the 529-to down payment strategy really the best use of these accounts? Or should families just save separately for a home? Lucas: It depends on your certainty about college. If you're pretty sure your child will pursue higher education, the 529 is still the best tax-advantaged vehicle for that. The down payment option is a nice contingency. But if you're torn between saving for college and saving for a home, I'd argue the 529 still wins because of the tax-free growth for education, and now the Roth rollover exit ramp. Luna: What about the risk of overfunding? If you put too much in a 529 and the child gets a full scholarship, you're looking at a ten percent penalty on any leftover that can't be rolled over. Lucas: Right. The Roth cap of thirty-five thousand is a limit. If you have a hundred thousand left over, you're paying penalty on sixty-five thousand. That hurts. So the key is to be conservative in your contributions, especially if you're early. You can always add more later. Luna: And if the child gets a scholarship, you can withdraw up to the scholarship amount penalty-free, but you still owe income tax on the earnings. That's another wrinkle. Lucas: Exactly. So the down payment strategy is really for families who are fairly confident the child will use most of the 529 but want a backup plan for the excess. It's not a primary savings vehicle for a home. Luna: Let's talk about state-specific programs again. Are there any states other than Ohio and Pennsylvania that have started allowing 529 funds for home buying? Lucas: As of May 2026, I'm aware of about five states that have introduced or passed legislation. Arizona, for example, has a bill in committee. New York is studying it. But you have to check the specific rules for your state because they vary widely. Some only waive the state tax recapture, others provide a small state tax credit for down payment withdrawals. Luna: So the bottom line: the federal framework doesn't directly allow it, but the Roth rollover path gives you a workaround. And states are slowly adding their own perks. Lucas: That's the summary. For a family starting today with a newborn, you have at least eighteen years to watch this space. I'd bet we see more state and federal changes. But for now, the smartest move is to fund a 529 with the understanding that it's primarily for education, and treat the down payment option as a nice to have bonus. Luna: And if the rules change, you'll be ahead of the game. Good stuff, Lucas. Lucas: Thanks, Luna. Next episode we'll look at how 529 plans interact with FAFSA simplification—there are some big changes coming for the 2027-2028 award year.