Have Unused Funds in Your 529? Starting in 2024, You Get This Option

If your goal is to save enough money for college to cover your kids' education in full, then you may need to pump a bundle of cash into a 529 plan. College costs have risen a lot over the past few decades. And it could easily take a six-figure 529 balance to leave your kids without any educational debt.

But what if you end up in the fortunate position of having too much money in your 529 plan? Because the money you put into a 529 doesn't get any tax-advantaged treatment, the same way contributions to a traditional brokerage account don't, you're not penalized if you withdraw your principal contributions for non-education purposes. But if you withdraw the gains portion of your 529 for non-education purposes, you'll be penalized on those gains to the tune of 10%.

Here's how that might work. Let's say you contribute $40,000 to a 529 plan and your balance grows to $75,000 because of your investments. If you were to take withdrawals for non-education purposes, only the $35,000 in gains would be subject to a 10% penalty -- not the $40,000 you put in.

Now you do have the option to designate a new beneficiary for your 529 plan if you end up with more money than you need for your kids' education. But that, too, limits you to a large degree.

The good news is that starting in 2024, you'll have the option to roll unused 529 plan funds into a Roth IRA without penalty. And that makes 529s virtually risk free from an excess cash perspective.

When you have more options for your money

Many people do their best to save for college only to wind up falling short. But you might land in the opposite boat, especially if you give yourself many years to save for that goal and you invest your money in a savvy manner.

The stock market has, over the past 50 years, delivered an average annual 10% return before inflation, as measured by the performance of the S&P 500. So, let's say you have one child and begin funding your 529 plan when they're a year old, leaving you with a 17-year investment window. If you're able to sock away $400 a month in your 529 plan during that time and score a 10% yearly return on your investments, you'll be sitting on about $195,000.

Meanwhile, let's say your child opts to attend a school that only costs $40,000 a year ("only" being a relative term, of course). That means you're left with an extra $35,000 in your 529 plan that you don't need.

Clearly, that's a good problem to have. But it is a problem nonetheless -- or at least it was until recently. Now, beginning next year, you'll have the option to move that money over to a Roth IRA and reserve it for your retirement. And to be clear, the amount of money you can roll from a 529 plan to a Roth IRA is limited to $35,000 per beneficiary.

A good way to eliminate worry

The aforementioned 529 plan change is a great way to alleviate a big concern associated with funding one of these accounts. So if you have a child whose college education you'd like to cover, it pays to consider opening a 529 plan as early as possible. The more time you give your money to grow, the more likely you are to end up in a situation where you have extra funds to move to a Roth IRA.