Happy Graduation! What Do We Do With This 529 Balance?

Brian Kearns, CPA, CFP, RIA Founder, Haddam Road Advisors
Best Practices in Financial Planning

It’s that time of year—graduation ceremonies and parties are here! The gowns are ordered, the travel plans are finalized, and as was the case when I was in school, the mortarboards don’t fit properly (full disclosure, I had to search for the name of the “tassel hat”).

For many American families, education planning is a multidecade enterprise: The parents opened a 529 college savings plan soon after their child was born, and tax-savvy grandparents helped by super-funding it when their grandchild was in diapers.

The 529 is a common tax-advantaged savings plan that many families use to help fund college expenses, including tuition, fees, books, supplies, room and board, etc. Of course, now that the diplomas are received, many of your clients may be asking you (their advisor): “What do we do with the outstanding 529 plan balance?”

For excess 529 plan funds, there are several options available, each with certain rules, limitations, and planning considerations. Some common options include: 1) designating a new beneficiary, 2) paying off education loans, and 3) funding further education.

However, thanks to the SECURE 2.0 Act, there’s a newer option—rolling over some or all the remaining 529 plan funds into a Roth individual retirement account (IRA) in the beneficiary’s name. This option offers an attractive planning opportunity to set up a new graduate with a retirement “nest egg.”

Notably, before the act was passed, this option would’ve incurred a 10% federal penalty and tax on account earnings for a non-qualified withdrawal. Also, when this option originally launched, there was very little guidance from plan administrators, but that has since been addressed (e.g., Illinois’ Bright Start college savings program now has a direct rollover to a Roth IRA form on its website).

SO, HOW DOES THE ROTH IRA ROLLOVER WORK?

There are a couple things to keep in mind when rolling over 529 plan funds into a Roth IRA.

First, there are time constraints to consider. Because the IRS wants to make sure genuine educational funds are being rolled over, the 529 plan account needs to have been open for at least 15 years. If you have clients with 6-year-old children, now’s the time to start funding new 529 plans so the Roth IRA rollover window can be an option for them by the time their children graduate college (I did say this was a multidecade enterprise).

Also, the 529 plan funds being rolled over to a Roth IRA need to have been in the 529 account for at least five years, so any contributions made while the student was matriculated may need to stay in the account for a bit longer depending on when the account was opened and contributions began.

Second, there are dollar constraints. The Roth IRA rollover option is limited to $35,000 per beneficiary (per lifetime). However, your clients wouldn’t transfer the funds in a lump sum. That’s because the IRS now considers graduates just like any other working-age person subject to the same contribution limits. The Roth IRA contribution limit for 2025 is $7,000, so this process could take five years or more to complete. Also, your working-age graduate needs to have earned income at least to the level of the Roth contribution for that year. (Welcome to the working world, graduate!)

OTHER CONSIDERATIONS

Beyond the Roth IRA rollover, there are other options for families to consider.

For instance, if there’s a line of children entering college, the 529 plan owner can change the beneficiary and use the balance to fund the next child in line. So, as an advisor, you might recommend having clients super-fund their eldest child’s 529 plan at the outset and then swap out the beneficiaries as each child graduates.

Also, be aware that combining the Roth IRA rollover and beneficiary change can be tricky if the siblings are close in age (sorry, the rule makers didn’t make this process easy). For cases like this, consider the timing of tuition outflow and the possible five-year window needed to fully complete a Roth IRA rollover when setting up a balance transfer.

Additionally, unused balances can help fund education prior to college. For example, if the younger siblings are in elementary, secondary, public, private, or religious school, the 529 plan can fund up to $10,000 per year of their tuition costs once they’re designated as the beneficiary.

Here are some common 529 plan questions that’ll likely arise from your clients as graduations approach:

• Can anything be done with student loans? Yes, student loan balances can be paid down with 529 plan funds (up to $10,000 per beneficiary). This is the lifetime limit for each 529 plan beneficiary.
• Can someone other than my children become a beneficiary of the balance? A 529 plan owner can make anyone who’s a member of the family a beneficiary without tax consequence (e.g., spouses, ancestors, children, stepchildren, grandchildren, great-grandchildren, aunts, uncles, nieces, nephews, and first cousins).
• What happens when the parents become grandparents? If there’s an outstanding 529 plan balance, they can designate a grandchild as a beneficiary—but keep in mind that there may be a generation skipping transfer tax liability (only if they’ve used up their gift exclusion of $13.6 million each). Most people won’t have this problem. Grandparents may need to file a gift tax return if the balance is over the yearly exclusion (currently $19,000 per grandparent, per recipient).
• What if the new graduate wants to go to graduate school? The balance can be used to fund a graduate degree with the same rules as an undergraduate degree.

As you can see, 529 plans offer a myriad of options when it comes to funding education for several generations. Of course, to make the most out of a 529 college savings plan for the owners and beneficiaries, mapping out a clear strategy well in advance of the tuition-funding years is critical to meeting their family’s needs and aspirations.

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