To all those parents and grandparents out there who are trying to help the kids with school: this is for you.
Rules around education investment accounts (529 accounts) have changed over the last few years. They are more flexible than ever; we can often use them to pay for college, trade school, apprenticeship programs, secondary education expenses, and even student debt! Sometimes it surprises clients how versatile these funds can be. Here are a few examples:
1. Laptops: does your student need a computer for college? No problem; this is a qualified education expense. You don’t have to wait until college, either—you can buy your grandson who is a junior in high school a computer as well and it will qualify.
2. Room and board: this is a common question. For someone who is in an eligible school/program and is at least a half-time student, this is a qualified expense. On campus and off campus living alike are eligible. A quick note, however: dual programs like Running Start where a student is in high school and taking college courses simultaneously aren’t eligible.
3. Student loan debt: up to $10,000 per student can be used from a 529 plan to repay student debt. This can be an attractive idea for parents or grandparents who want kids to have “some skin in the game”. The student can take on loans (often at subsidized interest rates), and not be required to pay while they are still in school. Also, student loans usually don’t add interest to principal while they are still enrolled—this keeps compound interest from working against them until after they graduate!
Then, after they graduate, you can pay off their debt using the 529 plan. This can be the reward for finishing their education and graduating. We have a fair number of clients who like this method; they believe that it keeps kids from feeling automatically entitled to parents paying for their college.
There are a few other beneficial side effects as well:
a. You can help young students establish good credit by allowing them to take on student debt and pay it off.
b. You also essentially extend the timeline for the 529 investments. There is a 6 month grace period after graduation for most federal student loans before repayment starts. Here is why this matters: imagine if you had a son or granddaughter starting college in August 2025. That would mean your first payment is due right around that time. However, if you decided to have the student take on loans temporarily, you could extend that timeline by potentially 4 years or more. This allows you to remain more growth-oriented in the 529 account for longer because you have a longer time horizon, which in turn means more money in the long run.
c. If your student doesn’t take school seriously and quits, you aren’t out the money. You can decide if you want to bail them out or have them pay for their time in school.
d. This also gives your student time in case they find a scholarship. Some students receive scholarships during college, not just before. For these students, you are allowed to take money out of the 529 account and use it for non-qualified things without a penalty. You just can’t take more than the scholarship amount out for non-qualified purposes. For example, suppose your senior in college receives a scholarship for her graduate degree abroad. She receives $32,000 from this scholarship. You could take up to $32,000 out of the 529 account and use it for non-qualifying expenses. You could buy her a car, pay for her extra-curriculars while she travels, or even buy yourself a car to celebrate how wonderful your daughter is. You would pay taxes on the growth (unlike a typical qualified distribution), but you would not pay the typical 10% penalty.
Alternatively, you could switch the money and spend it instead on another child’s education expenses. There would be no penalty or taxes paid at all for this.
One last thing: there is a special rule that allows you to roll over 529 money into a Roth IRA for the beneficiary. This isn’t easy—you can only roll over up to the Roth contribution limit each year ($7,000 for 2025). For a $20,000 education account, it could take 3 years of rollovers to move it into the Roth completely. You also can only do this if the 529 account is fairly old—at least 15 years old. There are some other nuances, so be sure to reach out to us if you are thinking this might be a strategy you want to pursue.
Although it may seem tedious, the result can be worth it:
Meet Ted. Ted is 22 years old, and his parents set up a 529 account that still has $30,000 left in it. Ted was originally headed to college, but he changed gears and became an electrician instead. They paid him during his apprenticeship and he never needed the money. His parents, being financially savvy, rolled over money into a Roth IRA for him from the 529 account. They had to do it over several years, and it looked like this:
IRA contribution limit: $7,000 for 2024
| Year | Rollover to Roth IRA | Remaining 529 assets |
|---|---|---|
| 2024 | $7,000 | $23,000 |
| 2025 | $7,000 | $16,000 |
| 2026 | $7,000 | $9,000 |
| 2027 | $7,000 | $2,000 |
| 2028 | $2,000 | $0 |
Ted rolled his eyes at first: this seemed like a lot of work to simply move money from one account to another. Ted’s eyes stopped rolling and widened in surprise when he saw the following calculation:
Ted’s age in 2028: 27
Ted’s theoretical retirement age: 67
Ted’s Roth assets in 2028: $30,000
Hypothetical rate of return in Roth: 9%
Ted’s Roth value at retirement: $942,282
Ted’s 529 education account, treated properly, allows him to be a tax-free almost-millionaire.
Helping one generation help the next is one of the most satisfying parts of being a financial advisor—please reach out to us if you have questions about education planning or helping the kids in general. Getting kids and parents (and grandparents!) on the same page with their planning is where the magic is.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that an education-funding goal will be met. In order to be federally tax free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10 percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.
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