A major barrier to 529 plans goes away in 2024, thanks to Secure 2.0

Up until now, 529 savings plans were widely considered the best way to save for college. But there was always a major sticking point, according to financial experts and plan investors.

The funds had to be used for qualified education expenses such as tuition, fees, books, and room and board. Even though the restrictions had loosened in recent years to include continuing education classes, apprenticeship programs and even student loan payments, any limitations on this future savings created “a mental barrier,” said College Savings Foundation Chair Vivian Tsai.

Starting in 2024 — thanks to “Secure 2.0,” a slew of measures affecting retirement savers — families can roll unused money from 529 plans over to Roth individual retirement accounts free of income tax or tax penalties.

“Most people’s objections are ‘what if I don’t use this money for education.’ Now you can use it for retirement,” Tsai said. “It removes a significant objection.”

“This is a big deal,” she added.

These plans have been steadily gaining steam for a number of reasons.

In some states, you can get a tax deduction or credit for contributions. A few states also offer additional benefits, such as scholarships or matching grants, to their residents if they invest in their home state’s 529 plan.

And yet, total investments in 529 plans fell to $411 billion in 2022, down nearly 15% from $480 billion the year before, according to data from College Savings Plans Network, a network of state-administered college savings programs.

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“Last year, we saw a pretty noticeable reduction in contribution behavior,” said Chris Lynch, president of tuition financing at TIAA. Regular contributions to a 529 college savings plan took a back seat to paying more pressing bills or daily expenses, he said.

Further, many would-be college students started rethinking their plans altogether. Some are opting out entirely or considering a local and less expensive in-state public school or community college. 

Now, 529s offer more flexibility, even for those who never enroll in college, Lynch said.

“A point of resistance that potential participants have had is the limitation around, what happens if my kid gets a scholarship or decides they’re not going to college,” Lynch said.

In such cases, you could transfer the funds to another beneficiary, or withdraw them and pay taxes and a penalty on the earnings. If your student wins a scholarship, you can typically withdraw up to the amount of the scholarship penalty-free.

However, the added benefit of being able to convert any leftover funds into a Roth IRA tax-free after 15 years, up to a limit of $35,000, “helps to eliminate that point of resistance,” he said.

“It becomes a no-brainer at this point,” said Marshall Nelson, wealth advisor at Crewe Advisors in Salt Lake City.

To be sure, there are still some limitations: the 529 account must have been open for 15 years and account holders can’t roll over contributions made in the last five years. Rollovers are subject to the annual Roth IRA contribution limit, and there’s a $35,000 lifetime cap on 529-to-Roth transfers.

Still, “we’re going to see a spike in 529 usage,” Nelson predicted.

Even if someone in their mid-20s put $35,000 in a Roth IRA and just left it alone, that could be close to $1 million 40 years down the road, he said.

“It’s something I see catching on,” Nelson added. “Now they have the option to use that money to supplement retirement; that’s a huge win.”