(This article originally appeared in the August 2024 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)

With the average cost of college running at more than $38,000 per student per year and annually rising higher than general inflation over the past decade, according to the nonprofit Education Data Initiative, it’s no wonder parents are doing whatever they can to try to save for their children’s education.

On average, Americans in 2023 saved $27,741 in their 529 education savings accounts, a type of investment account that offers tax-free withdrawals when used to pay for qualified education expenses.

While many may worry they haven’t saved enough for their kids’ college bills, others fear they might have overfunded their 529 accounts. This happens when there is money left over in the account after the original beneficiary is finished with their education. Perhaps the student received scholarships, used the GI bill, or attended a service academy. Any nonqualified distributions from the account incur a 10% tax penalty plus income tax on any gains.

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Luckily, some changes took effect in January 2024 that might help alleviate some parents’ worries. As part of the Secure 2.0 Act, which passed in December 2022, owners of 529 accounts can now make tax- and penalty-free rollovers to a beneficiary’s Roth individual retirement account (IRA). There are, however, several rules and limitations on this type of rollover.

Limits apply. The rollover amount can’t exceed the annual Roth IRA contribution limit, which is $7,000 in 2024 ($8,000 for those 50 and older). If the leftover amount is larger, rollovers might have to occur over a few years. And the rollover amount and any direct Roth IRA contributions are cumulative and the total can’t exceed the annual limit.

There is a lifetime limit of $35,000 per beneficiary for rollover contributions.

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Income limitations. The Roth IRA account holder must have earned at least as much income as they want to roll over in any particular year. And the Roth account holder must be under the IRS’s annual income limit to be eligible to make Roth IRA contributions.

Two different holding periods. You must own the 529 for at least 15 years before you are eligible to perform a rollover. Contributions made to the 529 plan in the past five years are ineligible for rollovers.

Ownership must match. The beneficiary of the 529 plan must be the owner of the Roth IRA.

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Since this provision was only implemented a few months ago, there are still some gray areas that haven’t been clearly defined.

For example, some state 529 plans don’t recognize Roth rollovers as qualified distributions. So even though the rollover might not be taxed on the
federal level, it could be taxed on the state level and there could be clawbacks of state-level tax credits or deductions.

Ownership rules are another murky area. Since 529 beneficiaries can be changed freely, it’s not clear whether changing a beneficiary on a 529 will trigger a new 15-year holding period.

There are already a few options out there for parents who might have overfunded a 529 account. They could transfer the money to another child or qualified relative, or even use some of the funds for their own educational needs.

If a child receives a tax-free scholarship or uses GI bill benefits, an equal amount can be withdrawn from the 529 without paying the 10% tax penalty, although income tax on the gains will still be owed.

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Since distributions from a 529 aren’t required, if an account owner wanted to leave assets to an as-yet unborn beneficiary such as a grandchild, they could make themselves the beneficiary of the account until the grandchild is born and assigned a Social Security number, allowing the funds to grow tax-free in the meantime.

While the new provision opens more options for people who are saving for college, it wouldn’t make sense at this point in time to intentionally “superfund” a 529 with a plan of rolling it to a Roth in the future. Still, this provision provides choices that did not exist previously.