Since their inception in 1996 through the Small Business Job Protection Act, 529 college savings accounts have steadily grown in popularity, reaching nearly $530 billion in total assets as of year-end 2024.
By offering tax-free growth and tax-free withdrawals for qualified expenses, 529s are tailor-made to help families better meet the increasing costs of a college education. Some states even offer income tax deductions for contributions.
In addition, recent legislative changes have expanded the range of expenses that can be paid for with tax-advantaged 529 account assets.
Even as 529 accounts were designed for college expenses, that doesn’t mean they’re optimal in all cases. As retirement planning experts Ed Slott and Jeff Levine discuss in the latest episode of the Great Retirement Debate podcast, there are some cases where saving for potential college expenses is better done in a Roth individual retirement account.
Reasons to Consider a Roth
Dollars put into a 529 plan account but used for purposes other than qualifying education expenses are very inefficient from a tax perspective, Levine and Slott noted.
Generally, clients would face both income taxes on the assets and a 10% penalty. Plus, Slott and Levine warned, the state may take back any related benefits, such as state income tax deductions.
“If you were to instead to save in the Roth for a college education and assuming you are 59.5 and you've had the Roth IRA for more than five years, everything that's in your Roth is tax and penalty free for whatever you use it for — including education,” Levine said.
For clients younger than 59.5 who want to tap the funds, it can still potentially be a good idea to go with the Roth account.
“Remember, you can withdraw Roth IRA contributions tax-free and penalty-free at any time, regardless of your age or holding period, again, including education,” Levine said. “Likewise, if you converted any money, any conversions that were made more than five years ago will be available penalty- and tax-free.”
This strategy will miss out on some tax-free growth available in a 529 account, but it could be beneficial if there are doubts that the money will be used or be needed for college expenses.
Another option, the duo explained, is to have the child take out loans and hold them while the parents let their Roth IRA continue to grow.
“Then, you could simply use that Roth IRA to help pay down the debt, perhaps after they graduate college or when you do reach the age of 59.5 and everything in the account is tax- and penalty-free,” Levine said.
Flexibility Has Improved
Of course, Slott and Levine emphasized, none of this means that Roth accounts are inherently superior to 529 accounts to save for college — especially as Congress has created a pathway to move money not needed for an education expense out of the 529 in a tax-efficient manner.
Thanks to the Secure 2.0 Act, a beneficiary of a Section 529 qualified tuition program can roll over a distribution from the account to a Roth IRA if certain requirements are met. The amount cannot be more than the Roth IRA annual contribution limit (currently $7,000), and the rollover must be made from a Section 529 account that has been open for more than 15 years.
Another rule to keep in mind is the $35,000 lifetime limit on rollovers for any given beneficiary. Given that the annual limit for Roth IRA contributions is a fifth of that amount, hitting the limit will require multiple years of coordinated rollovers.
As Slott emphasized, such distributions must be paid in a trustee-to-trustee transfer to a Roth IRA maintained “for the benefit of the designated beneficiary.” That is, the 529 plan account and the Roth IRA must have the same owner-beneficiary.
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