What Is the 529 Loophole for Student Loans and Roth IRAs?
Unlock new financial strategies for your 529 plan, including student loan repayment and tax-advantaged Roth IRA rollovers.
A 529 plan is a tax-advantaged savings vehicle designed to help individuals save for future education costs. Sponsored by states or educational institutions, these plans offer tax benefits for qualified education expenses. Contributions to a 529 plan are typically made with after-tax dollars, but the earnings within the account grow federal tax-free.
Withdrawals used for qualified education expenses are also free from federal income tax. This tax treatment makes 529 plans a valuable tool for funding educational pursuits, from kindergarten through graduate school and apprenticeship programs. The primary purpose of these plans is to encourage and facilitate savings for educational endeavors.
Using 529 Funds for Student Loan Repayment
The SECURE Act of 2019 expanded 529 plan usage, allowing funds for student loan repayment, effective for distributions after December 31, 2018. This addition recognized the growing burden of student debt and aimed to provide families with more flexibility in utilizing their education savings.
Qualified education loans, which include both federal and most private student loans, can be repaid using 529 funds. The payments can cover both the principal and interest portions of the loan. This option applies to loans taken out by the 529 plan beneficiary or their siblings.
A lifetime maximum limit of $10,000 per individual applies to these student loan repayments. This limit applies to the beneficiary and each of their siblings. Withdrawals for this purpose are considered qualified expenses, ensuring they remain federal tax-free.
Transferring Unused Funds to a Roth IRA
The SECURE 2.0 Act of 2022 introduced a provision allowing the rollover of unused 529 plan funds into a Roth IRA. This option became effective on January 1, 2024. This legislative change offers a pathway for families to repurpose education savings if the funds are no longer needed for qualified education expenses, potentially providing a boost to retirement savings.
Specific requirements must be satisfied for these rollovers to be tax-free and penalty-free. The 529 account must have been established for at least 15 years, and the funds held in the account for a minimum of five years. This prevents very recent contributions from being immediately transferred to a Roth IRA.
Annual rollovers are subject to Roth IRA contribution limits. For 2025, this limit is $7,000, or $8,000 for individuals aged 50 and older. This annual rollover amount is aggregated with any other contributions the beneficiary makes to a Roth IRA for that year. A lifetime maximum rollover limit of $35,000 per beneficiary applies from all 529 plans combined. The beneficiary of the 529 plan must also be the beneficiary of the Roth IRA receiving the funds.
Important Rules for These New Options
Certain rules apply to 529 plans when considering student loan repayment or Roth IRA rollovers. Withdrawals that do not meet the criteria for qualified education expenses, including these newly expanded uses, are generally subject to federal income tax on the earnings portion and a 10% federal penalty. The original contributions, however, are not penalized.
Maintaining records of contributions, withdrawals, and expenses is important for compliance. This documentation helps demonstrate that withdrawals were used for qualified purposes, whether for traditional education costs, student loan repayments, or Roth IRA rollovers.
These new options significantly expand the flexibility of 529 plans beyond their original scope. They offer alternative pathways for using accumulated savings if a beneficiary does not pursue higher education, receives scholarships, or has leftover funds. This adaptability makes 529 plans a more robust financial planning tool.
While federal rules govern these provisions, state-specific tax implications can vary. Some states offer tax deductions or credits for 529 plan contributions, and state tax treatment of withdrawals, particularly for Roth IRA rollovers, might differ. In some instances, a state may seek to recapture previously granted tax benefits if funds are rolled over to a Roth IRA. Additionally, changing the beneficiary of a 529 plan to another eligible family member is generally permitted without tax consequences at the federal level. However, certain beneficiary changes, particularly across generations, could have gift tax implications.