Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / How the SECURE Act Remade 529 Plans
Transcript
- Lucas: The single biggest change to 529 plans in a generation might actually be the one that lets you not use them for college at all. Luna: Wait — you mean the Roth IRA rollover provision from SECURE 2.0? Lucas: Exactly. As of 2024, families can roll unused 529 funds into a Roth IRA for the beneficiary — up to a lifetime limit of $35,000. And this is May 2026, so we're now two years into this rule being active. The question is: how many families actually understand the mechanics? Luna: And the traps. Because there are some pretty specific hoops you have to jump through. Lucas: Right. So let's start with the most basic constraint: the 529 account has to be open for at least 15 years before you can roll any money into a Roth IRA. And the contributions — not just the earnings — have to sit for at least five years before they're eligible. That means if you opened a 529 for your newborn in 2023, the earliest you could start rolling is 2038. Luna: So this isn't a loophole for someone who started saving last year and now wants to shift the money. It rewards long-term savers. Lucas: Correct. And there's another layer: the rollover counts as a Roth IRA contribution for that year. So the beneficiary has to have enough earned income to cover it. If your kid is 22 and working a summer internship earning six thousand dollars, you can only roll up to six thousand — or whatever the annual Roth contribution limit is. The $35,000 cap is lifetime, but it's subject to annual limits. Luna: That's a huge practical constraint. Most college graduates don't have high earned income right away. So the rollover might take several years to fully execute. Lucas: It could take six or seven years just to move the full $35,000. But here's the part that I think gets overlooked: the rollover also resets the five-year clock on the 529 for future contributions. So if you roll money out, any contributions you made within the last five years can't be rolled yet. You have to track the seasoning period. Luna: And that's where the paperwork gets messy. But let's talk about the big fear parents have: overfunding a 529. Before this rule, if your kid got a full scholarship or decided not to go to college, you were stuck paying a 10 percent penalty on earnings. Does this eliminate that risk entirely? Lucas: Not entirely, but it dramatically reduces it for moderate overfunding. Think about it: the average cost of four years at a public in-state university is roughly $110,000 today. If you saved $150,000, you could roll $35,000 into a Roth and then withdraw the remaining $5,000 of earnings with the penalty — but you'd still pay taxes on the earnings. Still, it's a much better outcome than before. Luna: Let's get concrete. Who is this really designed for? High-income families who can max out other retirement accounts and still have money left over for college savings? Lucas: Partly. But also for families who use a 529 as a multi-generational wealth transfer tool. You can change the beneficiary to a sibling, a cousin, even yourself. If you never use the money for education, you can roll it into a Roth IRA for yourself — assuming you have earned income. That opens up some interesting retirement planning strategies. Luna: But there's a state tax angle too, right? Some states claw back the state income tax deduction if you roll money out. Lucas: That's a critical point. As of early 2026, about a dozen states have issued guidance saying that a rollover to a Roth IRA is not a non-qualified withdrawal — so they won't recapture the deduction. But other states are still silent or treat it as a non-qualified distribution. If you live in a state with a high income tax, like California or New York, you could owe back taxes on the deductions you took years ago. Luna: So before anyone executes this rollover, they need to check their state's specific rules. That's not just a footnote — that could be thousands of dollars in unexpected tax. Lucas: Exactly. And let's talk about the timing of contributions. The rollover can only come from unused funds, meaning it can't exceed the amount of contributions and earnings that are not needed for education. But the IRS hasn't given clear guidance on how to calculate 'unused' — do you have to exhaust all education expenses first? Most advisors I've spoken to say no, you just need to have remaining funds after paying for qualified expenses. Luna: That leaves a lot of gray area. And what about student loans? Can you use 529 funds to repay loans and then roll the rest into a Roth? Lucas: Yes. The SECURE Act also expanded 529 qualified expenses to include student loan repayments — up to $10,000 lifetime per beneficiary. So you could theoretically pay $10,000 in loans, then roll $35,000 into a Roth, and withdraw any remaining earnings with a penalty. The key is to sequence it correctly: loans first, then rollover, then distribution. Luna: It feels like the government is trying to encourage a 'save for college, but if you don't use it, save for retirement' mindset. That's actually pretty elegant policy. Lucas: I think so. But it also creates complexity. For example, the 15-year clock applies to the entire account — not to each contribution separately. So if you open a 529 for your child at birth, make contributions for 15 years, and then your child decides not to go to college, you can immediately start rolling funds into a Roth IRA. But if you opened the account when they were 10, you'd have to wait until they're 25. Luna: And that's assuming the beneficiary is the same. If you change the beneficiary to another family member, does the 15-year clock reset? Lucas: The IRS hasn't explicitly said, but the prevailing interpretation is that if you change the beneficiary to someone who is not a member of the same generation — say, from a child to a grandchild — the clock might reset. But if it's a sibling or cousin, the original account opening date likely stands. It's unclear. Luna: So there's still a lot of uncertainty. And uncertainty makes people hesitant to change their strategy. Lucas: Which is why I think the best approach is to treat the Roth rollover as a safety valve, not a primary strategy. Continue saving for education with the expectation that you'll spend it on tuition. But if you end up with extra, the Roth option is a fantastic Plan B. Luna: Let's do a quick case study. Say a family in Ohio started a 529 in 2018 for their daughter. They contributed $5,000 a year. By 2026, they've put in $45,000, and with growth, the account is worth $60,000. Their daughter gets a full scholarship, so they only need to cover room and board — maybe $20,000 over four years. They're left with $40,000. Lucas: Great example. They can roll $35,000 into a Roth IRA for the daughter, starting as early as 2033 — because the account was opened in 2018, that's 15 years. But the daughter needs earned income each year. If she's a graduate student with a stipend of $25,000, she can contribute the full annual limit. They'd also check Ohio's state tax treatment. Ohio has confirmed that the rollover is not a recapture event, so they keep their state deductions. Luna: And the remaining $5,000? They'd pay income tax on the earnings portion, plus a 10 percent penalty. But that's a $500 penalty on maybe $2,000 of earnings — so $200 in tax and $200 penalty. Total cost $400 to access the $5,000. Not bad. Lucas: Compare that to before SECURE 2.0: they would have paid penalty and tax on the entire $15,000 of earnings — roughly $3,000 in tax plus $1,500 penalty. The new rule saves them thousands. Luna: So the real win is for families who oversave modestly. If you oversave by $100,000, the $35,000 rollover helps but you're still stuck with a big tax bill on the rest. Lucas: That's right. The rollover cap is $35,000, which is about one year of tuition at a private university. It's not a panacea for massive overfunding. But it does make the 529 a lot more flexible. And I suspect we'll see more states clarifying their rules over the next year. By 2027, I'd expect all 50 states to have a position. Luna: One last thing: what about grandparents who own 529s for their grandchildren? Can they do the rollover? Lucas: Great question. The rollover must go into a Roth IRA owned by the beneficiary — the grandchild. So the grandparent would need to change the account ownership to the grandchild first, or distribute the funds to the grandchild, who then contributes to their own Roth. But that distribution might be considered a gift for tax purposes. It's complicated. Luna: So the simplest use case is a parent-owned 529 for a child who eventually has earned income. That's the cleanest path. Lucas: Cleanest, yes. And also the most common. The SECURE 2.0 Act didn't get a lot of attention when it passed, but this provision might end up being the most impactful for middle-class families who are diligent savers. Luna: It's a nice reminder that tax-advantaged accounts can evolve. The 529 was originally just for tuition. Now it's a hybrid education-retirement vehicle. Lucas: And that evolution isn't done. I expect we'll see proposals to raise the $35,000 cap or eliminate the 15-year waiting period in future legislation. But for now, this is the tool we have. Luna: So if you're a parent with a 529 and a kid who might not use all the money, it's worth talking to a financial advisor about whether a Roth rollover fits your plan. Lucas: Absolutely. And do it before the end of the year, because the rollover counts as a Roth contribution for the tax year it's executed. You don't want to miss the window if your child has earned income this year. Luna: Great advice. Next episode, we'll look at how 529 plans interact with financial aid formulas — because that's another piece of the puzzle that often surprises families. Lucas: Looking forward to it. For now, I think the key takeaway is: the 529 just got a lot more forgiving. Save aggressively, but know you have an exit ramp.