Saving for the High Cost of College: New Rule Offers Additional Options

Most Americans agree that money spent on higher education is critically important, as assets invested for this purpose can significantly influence the trajectory of a young person’s life. Many parents and grandparents strive to support their children in pursuing higher education, and for a dermatology practice owner, this expense can impact how they plan their practice finances.

However, the rising costs make this increasingly difficult. According to 2019–2020 figures from the College Board®, the average annual tuition and fees were $36,880 for private colleges and $10,440 for in-state public universities.¹ Thus, the 4-year cost at a private institution may exceed $147,000, excluding inflation. These estimates do not include room and board, books, supplies, or miscellaneous expenses. Tuition increases at many institutions have far outpaced inflation, making higher education increasingly inaccessible. While student loans are available, if mismanaged, they may burden young adults with long-term debt.

529 plans offer a way to fund education, providing a form of “scholarship” through compound interest over time. These state-sponsored, tax-advantaged savings accounts, authorized under Section 529 of the Internal Revenue Code, are designed to help save for education expenses.

Types of 529 Plans

529 Prepaid Tuition Plans: These plans allow you to prepay tuition at today’s rates for use in the future when your beneficiary (the student) attends a participating college or university. This can be a good option to lock in tuition costs and hedge against future increases.

529 Savings Plans: These are investment accounts that allow you to save for education expenses such as tuition, fees, books, supplies, and even certain room and board costs. The money you contribute to a 529 savings plan is invested in a variety of places, typically including mutual funds or similar investment vehicles. The earnings on these investments can grow tax-free, as long as they are used for qualified education expenses.

529 Plan Basics

529 plans have been great educational tools to help families save money for college and use that money, tax-free, to pay for college expenses. While the plans are still relatively young, they continue to adapt and get new benefits as the popularity of using these accounts continues to rise. The advantages of 529 plans are numerous:

Tax Benefits: Contributions to 529 savings plans are not federally tax-deductible, but the earnings grow tax-free if used for qualified education expenses. Many states also offer state income tax deductions or credits for contributions to their own state’s 529 plan.

Qualified Expenses: Qualified education expenses can include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. Additionally, up to $10,000 per year per beneficiary can be used for K-12 tuition expenses.

Flexibility: 529 plans offer flexibility in terms of changing beneficiaries. If one child doesn’t use all the funds, you can often change the beneficiary to another eligible family member without incurring penalties.

Contributions: While there are maximum limits to how much you can contribute to a 529 plan, these limits are generally quite high, often exceeding $300,000 or more depending on the state.

Recent Rule Offers Added Flexibility

We often hear from parents and grandparents about the rigid rules for qualified distributions from 529 plans. Many worry that funds will be stranded in 529 plans by children who don’t use them. 

While 529 funds are supposed to be earmarked for education expenses, a new Roth IRA transfer provision provides a workaround for balances that aren’t being used for educational purposes. Without the provision, the growing, unused funds would be taxed at the investor’s income tax rate—and if the funds were used for ineligible expenses, the money would get hit with a 10% tax penalty.

As of 2024, taxpayers with 529 plan balances will be able to transfer those balances to Roth IRAs. However, this provision comes with many rules and restrictions, including:

A lifetime maximum of $35,000 can be rolled over from a 529 plan to a beneficiary’s Roth IRA.

Annual Roth IRA contribution limits apply to rollovers (in 2023, the limit is $6,500, which means it would take six years to convert $35,000 from a 529 plan to a Roth IRA).

Because the annual transfer amount is subject to the IRA limit, the beneficiary must have compensation.

Conversions can only be made to a beneficiary’s Roth IRA; a parent saving with a 529 plan in a child’s name cannot convert unused funds back into their own retirement account.

Rollovers are not allowed until a 529 account has been open for at least 15 years.

Contributions to the 529 plan made within the previous 5 years (and the earnings from those contributions) are not eligible to be transferred.

As an example, Dr. Smith is the owner of a 529 plan for his daughter, Jane (who is 25). Dr. Smith opened the account when Jane was an infant. The account had more than was needed for Jane’s education, and Jane has no further plans for formal education. Jane has no siblings and currently has no children. Let’s assume the 2024 IRA contribution limit remains at the current limit of $6,500. Dr. Smith can transfer $6,500 in 2024 to Jane’s Roth IRA account, assuming Jane has not made any IRA contributions in 2024 and Jane has compensation income. He can continue to transfer $6,500 per year (or the indexed IRA contribution limit amount) into Jane’s Roth account annually until he has transferred $35,000 into the account from the 529 plan. Jane’s Roth IRA will grow on a tax-deferred basis, and she will be able to take tax-free distributions from the account after age 59½.

This new rule helps families who have set aside funds in 529 plans avoid taxes and penalties if the beneficiary ultimately finds an alternative way to pay for higher education. Roth IRA income limits do not apply to these transfers, making this option attractive even to high-income investors who were previously ineligible.

With careful planning, 529 plans remain powerful tools for funding education and retirement goals through tax efficiency and compound growth. 

1. College Board. Trends in College Pricing 2019. College Board; 2019. Accessed April 22, 2025. https://research.collegeboard.org/media/pdf/trends-college-pricing-2019-full-report.pdf