Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / 529 Plans as a Backup Retirement Account
Transcript
- Lucas: If you've been putting money into a 529 plan for your kid, there's a question that hangs out in the back of your mind: what happens if they don't use it all? Luna: Right. You hear the horror stories — someone's thirty-five, no kids, and they've got a hundred grand stuck in a state account. Lucas: Exactly. The old answer was basically: change the beneficiary to a cousin, or take the money out and pay a penalty. But SECURE 2.0 changed that in a big way. Starting last year, you can roll leftover 529 money directly into a Roth IRA. Luna: And that's a huge shift. It basically turns the 529 into a backup retirement account. Lucas: Let's talk through the details, because there are some very specific rules. First, there's a lifetime cap: thirty-five thousand dollars per beneficiary. That's the total you can ever move from a 529 into a Roth IRA for that person. Luna: So if you've saved fifty thousand and the kid only uses twenty, you can only roll thirty-five of the remaining thirty? Or does it work differently? Lucas: That's roughly right. But there's also an annual limit. The rollover counts against the beneficiary's normal Roth contribution limit — for twenty twenty-six, that's seven thousand dollars. So you can't dump thirty-five all at once. It has to happen over several years. Luna: And the beneficiary has to have earned income too, right? Same as any Roth contribution. Lucas: Correct. The rollover is treated as a regular Roth contribution, so the beneficiary needs enough earned income to cover it. That's a big catch for, say, a recent grad who's still job hunting. Luna: And there's a waiting period too, isn't there? The 529 has to have been open for at least fifteen years. Lucas: Right. The account must have been established for at least fifteen years before the rollover. And any contributions made in the last five years are ineligible. So you can't just open a 529, fund it, and immediately roll it out. Luna: And if the beneficiary never goes to college at all? Can they still roll it over? Lucas: Yes, as long as the fifteen-year clock is met. The money doesn't have to be used for education first. So a grandparent could set up a 529 for a newborn, and twenty years later if that kid decides to skip college, the money can go into their Roth. Luna: That's honestly a game-changer for families who were nervous about over-saving. Lucas: A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it really makes a difference. And we love keeping the show ad-free. Lucas: Alright, back to the rollover mechanics. One thing that trips people up is that the rollover counts as a Roth contribution, so you can't exceed the annual limit. But the beneficiary can also make their own Roth contributions alongside the rollover, as long as total contributions don't exceed their earned income or the seven thousand dollar cap. Luna: So if a recent grad earns forty thousand, they could put seven thousand of their own money in, plus seven thousand from the 529 rollover — as long as total doesn't exceed their income? Lucas: Actually no. The rollover itself counts as their annual contribution. So they can't add their own seven thousand on top. The total Roth contribution limit is seven thousand for twenty twenty-six. The rollover uses part or all of that. They can still contribute separately, but the combined total can't exceed seven thousand. Luna: Got it. So the rollover essentially crowds out their own contribution room. Lucas: Exactly. That's a key point for planning. If your kid is in a high-earning field right out of school, they might want to use their own Roth space. The rollover might be less valuable to them. Luna: But for a kid who's in grad school or a low-paying first job, it's a great way to jump-start their retirement savings. Lucas: Right. And there's another wrinkle: the 529 must have the same beneficiary as the Roth. You can't change the beneficiary to yourself and then roll it over. So if you're a parent who overfunded a plan for your child, only the child can do the rollover. Luna: What about the parent's own 529? Say they opened one for themselves years ago and never used it. Lucas: That's allowed. The beneficiary is themselves, so they can roll it into their own Roth. Same rules apply: fifteen-year account age, contributions older than five years, and the thirty-five thousand lifetime cap. Luna: So it's not just for kids. Adults can use this too, if they have a leftover 529 from a career change or something. Lucas: Exactly. Now, one question I get a lot: does this affect financial aid? The money in a 529 is already counted as an asset of the parent or student. When it rolls into a Roth, it's no longer counted for FAFSA purposes, which could actually improve aid eligibility. Luna: But the Roth distributions in retirement aren't counted as income for aid either, so it's a double benefit. Lucas: Right. And the rollover itself isn't a taxable event. The 529 money goes in after-tax, and the Roth comes out tax-free in retirement. No penalty, no income tax. Luna: So the main downside is just the complexity. You have to track the account age, the contribution dates, and the beneficiary's earned income. Lucas: And there's no do-over. If you roll money into a Roth and then realize you needed it for education, you can't pull it back out without penalty. So the timing matters. Luna: Let's walk through a real example. Say you started a 529 for your daughter in 2010. She graduates college in 2028 with some money left. Can you start rolling in 2028? Lucas: Not quite. The account was opened in 2010, so fifteen years is 2025. That's fine. But any contributions made after 2023 — within five years of the rollover — are ineligible. So if you added money in 2024 or later, that portion can't be rolled over until those contributions are older than five years. Luna: That's a gotcha. So you need to stop contributing to the 529 at least five years before you plan to start the rollovers. Lucas: Exactly. And since the annual rollover limit is seven thousand, and the cap is thirty-five thousand, it takes at least five years to move the maximum. So you'd need to plan a decade out. Luna: But what if the beneficiary has no earned income in a given year? Say they're in grad school full-time. Lucas: Then no rollover that year. The rollover can only happen in years when the beneficiary has at least that much earned income. So it might stretch out even longer. Luna: So the strategy really favors families where the kid starts working early, or where the 529 was opened very early. Lucas: Right. And there's a planning opportunity for grandparents. If they set up a 529 for a grandchild at birth, by the time the kid is fifteen, the account is eligible. If the kid doesn't go to college, the rollover can start at age fifteen, assuming they have a summer job. Luna: That's actually a great way to fund a Roth for a teenager. They'd have to have earned income, but a part-time job would cover a few thousand. Lucas: Exactly. And the grandparent's contribution is a gift, but the Roth belongs to the grandchild. It's a clever multigenerational wealth transfer. Luna: One thing I'm wondering: does the rollover affect the 'kiddie tax' rules for minors? Lucas: It doesn't, because Roth contributions are made with after-tax money and aren't considered unearned income. So no kiddie tax issue. Luna: Good to know. So the main takeaway is that SECURE 2.0 made the 529 much more flexible, but only if you proactively manage the timeline. Lucas: Exactly. If you're planning to use this strategy, you need to track the account opening date, stop new contributions five years before the first rollover, and make sure the beneficiary has earned income each year. It's not set-and-forget. Luna: But for families who do plan ahead, it's a rare win-win: either the money goes to education, or it becomes a retirement nest egg. Lucas: And with the thirty-five thousand cap, it's not going to fund a whole retirement. But it's a nice boost — especially for a young person just starting out. Luna: I think that's really the key audience here: parents who are worried about overfunding. This takes the fear out of saving too much. Lucas: Right. And it's worth running the numbers. If you save fifty thousand today and your child only uses fifteen, you can move thirty-five into their Roth. That could grow to over three hundred thousand by retirement, tax-free. Luna: That's a powerful argument for starting early — even if you're not sure college is in the cards.