529s as Retirement Plans
With Secure 2.0 allowing you to move leftover 529 money to a Roth IRA, is now the time to talk about 529 retirement plans? Should you use a 529 plan as a bonus retirement account?
Of course, 529 plans are intended for future educational expenses.
They grow tax-deferred, and qualified educational expenses are distributed tax and penalty-free. It’s kind of like a Roth IRA!
What about using a 529 as a bonus retirement account, especially for those who already max out available retirement plans, Health Savings Accounts, and backdoor Roth IRAs?
Why Bother With a 529?
Why Bother?
Why bother investing for retirement in a 529 plan?
Super-Savers already max out available retirement plans, including backdoor Roth IRAs and HSAs, to maximize tax-sheltered accounts. They are ultra-tax efficient and conscientious about their future.
What is the next step with investing? You can invest in a brokerage account. If you want to own real estate, now is also a good time. Both provide tax-efficient investment opportunities and are better than using variable or fixed-indexed annuities for tax deferral.
If you are with me so far, you might consider a 529 plan for retirement.
But They are Not Intended for Retirement, you say?
Think about this: Roth IRAs are not intended for use as retirement accounts for those who make above a certain amount (that’s why they have income limits). Yet, we use them through the backdoor!
So, why not consider a 529 plan as a retirement account? We already use Roth IRAs and HSAs as retirement accounts. Why not a 529? Again, you are smart, tax-efficient, and conscientious. Use the tax code to your advantage.
This is not a basic review of 529s. Don’t invest for your children’s education based on what you read here.
Advantages of Investing for Retirement in a 529
529s have no contribution limits. Thus, you can stuff as much money into one plan (or multiple plans in different states) as you want. Individual states have contribution limits, but you can name yourself beneficiary of the 529 and use multiple state plans. In addition, there is no income limit. Remember, per the IRS, 529 plans are intended for educational expenses only, so be reasonable with your stuffing. If you name someone else as beneficiary, you have a super-funding maximum of 5 years of gifts. If you name yourself (or your spouse), you can put as much in as you can justify to the IRS.
You also might get a state tax deduction. If you live in a state with a state tax deduction, you might consider taking advantage of this every year.
And this is the key: tax-deferred. So, there is no tax drag on the money invested in 529s.
Downsides of 529s as Retirement Accounts
The largest downside is a whopper (but there are ways around it).
For non-qualifying withdrawals of 529s, you pay ordinary taxes plus a 10% penalty. This is seemingly a large hurdle to overcome, but let’s break it down.
First, you don’t pay any tax or penalty on your basis. So if you put in $100,000, you get that out free and clear.
Taxes and penalties are only paid on growth. Say your $100,000 grows to $150,000. If you pull the whole thing out, you would owe ordinary income taxes on $50,000 and have a $5,000 penalty. If you only pull out $75,000, you would owe ordinary income taxes on $25,000 (since 2/3 is your basis) and have a $2,500 penalty.
How can you get around first ordinary income taxes and then the penalty?
Ways to Avoid Ordinary Income Taxes
Folks who retire early have an amazing Tax Planning Window when their income is low after retirement (and before RMDs). This is the ideal time to do Roth Conversions.
You can do many things during this window, like capital gain harvesting or even Roth ladders, or you could even fill your standard deduction with a 529 withdrawal.
Or, what if you have qualifying expenses during retirement? Do you want to be at least a half-time European student for six months? No taxes are owed for qualified expenses!
What about the Penalty?
What about that 10% penalty?
When you think about it, 10% isn’t much of a hurdle to overcome when you’ve used up all your other optimized tax space. But, on the other hand, if the alternative is 23.8% capital gains tax, then 10% sounds fine.
Remember, the penalty is only on the growth, and there is no penalty on qualified expenses.
Other Issues to Consider Before Investing in a 529 Retirement Plan
There are estate tax issues with 529s. They are considered irrevocable gifts, so they are not included in your estate for estate tax purposes. Remember, estate taxes may become an issue again in 2026, when TCJA expires.
In addition, many states have asset protection laws for 529 plans.
There may be issues with re-capture tax in your state. If you move the funds before 3 or 5 years to a different state’s plan, this is a consideration.
In essence, 529s have state-specific issues. Do your research!
Secure Act 2.0 and 529 Retirement Plans
Secure Act 2.0 made 529 retirement plans even more beneficial if you think far ahead.
You can now transfer 529 money to the Beneficiary’s Roth IRA. But:
- Max $35,000
- The transfers are subject to IRA contribution limits
- The 529 plan is at least 15 years old, and you can’t transfer contributions made in the most recent five years (or any earnings)
Conclusion – 529 Retirement Plan
If you are a Super-Saver and already maxing out your tax-preferred space, look into a 529 as a bonus retirement account.
This is especially true if you get a state tax deduction for a contribution and there is no recapture tax in your state.
There, the money grows tax-deferred. Use it for your bond location or other tax-inefficient investments.
Using a 529 as a retirement account won’t rock your world, but for efficient Super-Savers, neither will backdoor Roths or HSAs.
Consider it tax diversification; it’s always nice to have options. These options are even better after Secure Act 2.0!