By Dr. Jim Dahle, WCI Founder

I have been getting some variation of the following question every week since the day the Secure Act 2.0 passed.

“Given the Secure Act 2.0 provision that allows for conversion of a 529 to a Roth IRA up to $35,000 if it's been open for 15 years, do you see any downside to opening 529s for myself and my wife, funding to the level that they'll be expected to be $35,000 or so in 15 years and then converting to Roth? It wouldn't be a large percentage of the overall portfolio but still potentially an extra $70,000 of Roth contributions. Appreciate any input on the subject.”

If you have no idea what I'm talking about, here is what I said about this particular section of the Act the week it passed in 2022.

ΔSection 126: 529 to Roth IRA Rollovers Now Allowed

Once the 529 has been established for 15 years, 529 beneficiaries can roll up to $35,000 from their 529s into their Roth IRAs. This is not an addition to their annual contribution but a replacement for it. Basically, if you oversave for college, newly graduated students can use their $6,000ish per year for something besides Roth IRA contributions and still get their Roth IRA funded. There is no income limitations either, like with direct Roth IRA contributions. This won't change what I do with leftover 529 money for most of my kids (that will go to the grandkids), but it will for leftover 529 money I have saved for nieces and nephews. Starts in 2024.

Today, let's talk about this possible 529 to Roth IRA rollover a little bit more.


Another Escape Valve for a 529

The way this is intended to be used—and, honestly, the way I think it should be used—is as an additional escape valve for an overfunded 529. People worry about putting too much into 529s. They worry that they'll oversave for college and then need the money themselves, which means they'd have to pay the 10% penalty plus ordinary income tax rates on the gains in the plan when they withdraw it for something other than an approved educational expense. This fear inappropriately keeps them from using this excellent college savings vehicle, so the government is trying to minimize that fear.

Before the Secure Act 2.0, there were already a fair number of escape valves. First, the principal always comes out tax- and penalty-free. Those penalties only ever applied to gains in the plan. Second, if your kid went to a military academy, got a scholarship, or received employer educational assistance, you could take out an amount equal to what they received without having to pay any penalty. Third, if the beneficiary dies or becomes disabled, you can also avoid the penalty on withdrawals (and, in fact, may wish to consider a rollover to an ABLE account for the now-disabled person).

None of those are really the best thing to do with an overfunded 529. I now have four 529s that are likely overfunded given my childrens' educational plans. My plan is simply to change the beneficiary to my grandkids. Voila! Not only does that occur without any penalty, but it also avoids any tax being applied to the earnings. Plus, it provides an additional 2-3 decades of tax-protected growth. What's not to like?

Starting in 2024, there is one more escape valve to a 529—the 529 to Roth IRA rollover. Up to $35,000 (not indexed to inflation) can be rolled over to THE BENEFICIARY'S Roth IRA tax- and penalty-free. There are some rules, however.

  1. The money must have spent at least 15 years in the 529
  2. The rollover replaces the regular Roth IRA contribution for the year; it is not in addition to it.
  3. You cannot roll it all in at once, only an amount equal to that year's contribution limit. For example: $7,000 in 2024.
  4. The $35,000 is not indexed to inflation.
  5. The beneficiary must have sufficient earned income to make the contribution. That means a retiree or a single unemployed person can't do a 529 to Roth IRA rollover because there is no earned income.

More information here:

How to Superfund a 529 Plan


Doing 529 to Roth IRA Rollovers for Yourself

However, nobody who has been emailing me for the last year is really interested in using the 529 to Roth IRA rollover as an escape valve. They are most interested in doing this for themselves. They're typically a 40-year-old doctor who is really into personal finance, does a Backdoor Roth IRA each year, and does all that can be done to lower the average expense ratio in the portfolio. They're maximizers (rather than satisficers) in every sense of the word. They want to eke out every benefit they can from their investments and the tax code.

For these maximizers, I want to do two things today. First, I want to attempt to quantify the size of the potential benefit of doing this so they can properly decide if the juice is worth the squeeze. Second, I want to make sure they understand all of the ways this can go sideways on them.


What Is the Maximum Potential Benefit?

What is the maximum benefit you can get from opening a 529 for yourself, letting the money sit there for 15 years, and then rolling it over to a Roth IRA instead of making your regular Roth IRA (presumably Backdoor Roth IRA) contributions for the next 3-4 years or so. Why 3-4 years? Because that $35,000 is not indexed to inflation but the annual IRA contribution limit is. Presumably in 15-18 years at 3% inflation, you'll be making an annual IRA contribution of something like $11,500.

In reality, the benefit comes down to the tax savings on the money for being in a tax-protected account instead of a taxable account. For simplicity's sake, let's run our example for 17 years. Now, we need to make some assumptions. My assumptions seem reasonable to me. If they do not to you, then change them and run the numbers yourself.

I'm going to assume 8% returns before taxes and before 529 fees but after expense ratios. I'm going to assume an 18.6% Long Term Capital Gains/Qualified Dividend bracket throughout. I am going to assume a 0.13% 529 fee (this is the fee in the Utah 529 for a customized asset allocation). We're going to assume the yield on the investments is 2% a year and is all qualified dividends. We are going to assume you're in a tax-free state. We also assume that you're already maxing out all of your other tax-protected accounts, so we're just comparing investing in taxable to investing in a 529.

529 to roth ira rollover

If we're going to earn at 8% or so, we'll assume that we're only talking about putting something like $10,000 in there initially. That's because $10,000 growing at 8% a year is equal to $37,000 after 17 years.

In the taxable account, that $10,000 will compound at 8% – (2% × 18.6%) = 7.63%. So, $10,000 growing at 7.63% per year for 17 years is $34,903. Now, we'll also need to pay LTCGs on the gains. However, the gains are not just $34,903 – $10,000 = $24,903. The basis is higher than that because of the reinvested dividends. For example, in the first year, you're reinvesting $163. In the last year, you're reinvesting $528. Just to make it easy, let's assume $5,100 ($300 × 17) of that $24,903 is also basis. So the LTCG tax is 18.6% × ($34,903 – $10,000 – $5,100)  = $3,683. The total amount left after tax is $31,220.

In the 529, that $10,000 will compound at 8% – 0.13% = 7.87%. After 17 years, you'll have $36,250. The difference is $36,250 – 31,220 = $5,030.

The best-case scenario is that this scheme is going to net you something like $5,000 or about $10,000 if you do it for your spouse too.


What Can Go Wrong?

While $10,000 may not be all that much in comparison to a physician retirement nest egg of $2 million-$10 million, it sure beats a kick in the teeth. Why not do it? Ten grand is 10 grand. Actually, there are a few reasons why you may not wish to do this.


#1 You May Not Have Earned Income in 15 Years

Maybe in 15 years, you'll be retired, but you still want to spend this money on yourself and not just change the beneficiary to a grandkid. Now what? Well, you now have to pull the money out of the 529 and pay taxes and a 10% penalty on it. Let's say you're in the 24% federal bracket. How much of that $36,250 is going to disappear?

($36,250 – $10,000) × (24% + 10%) = $8,925

You're going to be left with $36,250 – $8,925 = $27,325, which is $3,895 less than you would have if you had just invested it in the taxable account in the first place.


#2 Maybe Congress Changes the Law

Congress could change the law or the IRS could change how it is implemented. Maybe it becomes means-tested. Maybe this option goes away completely. Or it becomes attached to an additional penalty. Either way, you still have money stuck in a 529 that you wish you had just invested in a taxable account.


#3 You Deal with the Hassle

Now you have an extra account (or two) to deal with each year. Simplicity is worth something. Is it worth $5,000-$10,000? Only you can decide.


#4 Death, Disability, Divorce, Dementia, Delirium

What if one of the Ds gets to you in the next 15-18 years? The odds are not zero. Now, this additional complexity becomes someone else's problem. Is that person capable of maintaining this plan to leave this money alone for 15 years and then do three or four rollovers into your Roth IRA? If you die, will the contingent beneficiary be able to keep the plan going for them (i.e., earned income in 15 years and a sophisticated financial understanding)? Seems doubtful.


#5 What If You Need the Money Early?

Admittedly, this seems unlikely given that you're maxing out all your tax-protected accounts, but it could happen. Again, you'll be paying ordinary income tax rates plus 10% on the earnings.


#6 What If You Can Invest Very Tax Efficiently in a Taxable Account?

Katie and I don't pay capital gains taxes—at least not so far in our life—and I'm sure we wouldn't pay on a $37,000 bill. We've just got too many capital losses saved up from tax-loss harvesting and we're charitable enough that we can flush many of the capital gains out of our taxable account and into our Donor Advised Fund. If you take away that final LTCG bill, the maximum benefit of the 529 to Roth IRA scheme is only about $1,350 a piece, just over ¼ of the maximum benefit. The potential penalties also seem much larger in comparison to that smaller potential benefit.


#7 What If 529s Don't Get Much Asset Protection in Your State?

Imagine you live in Hawaii and, thus, your 529 has no asset protection. If your other option would have been to put the money into a taxable account inside an asset protection trust (which is allowed in Hawaii), an (admittedly rare) above policy limits judgment not reduced on appeal could get that money.

More information here:

529s, Inheritance, and Roth IRAs for Kids

Despite Our Student Loan Debt, Here’s How We’re Filling Our Kids’ 529s


The Bottom Line

OK, we've quantified the benefit. It's probably a four-figure amount. We've outlined the risks and hassles involved. Now you have to make a decision. My decision is that I'm not going to do this for Katie and me. It introduces a little more complexity into a plan that is already pretty complex, and $10,000 just isn't going to move the needle for us.

What do you think? Are you funding a 529 for yourself while planning to use it for your Roth IRA contributions in 15-18 years? Why or why not? Comment below!