A new Roth IRA conversion option for unused money in 529 college savings plans, which went into effect this year, is likely to spur more college savings, according to a new survey from Saving For College, a data tracker and advocacy group that’s part of Backer, a fintech provider.
“Leftover funds in 529 accounts were not a big problem,” said Martha Kortiak Mert, Saving for College’s chief operating officer. “However, the concern that 529 funds would not be used has been a major psychological barrier for many parents who prefer to use a taxable account to save for college because of the perceived flexibility.”
529 accounts allow parents to save money tax-free for their children and/or grandchildren’s educational expenses. They’re funded with after-tax dollars, and the funds can grow tax-free. Qualified withdrawals are free from federal income taxes.
But this is the first year that extra money in the account can be rolled over to a Roth IRA without incurring federal taxes or penalties, though strict rules apply.
Of those surveyed, 76% of respondents who don’t yet have a 529 plan said that the option of converting leftover money to a Roth IRA makes them “much more likely” or “somewhat more likely” to open a 529 plan.
Of those who already own a 529, 72% said they were aware of this new option, and 57% said that the new option makes them more likely to increase their contributions to their 529 plans.
Uncertainty about how contributions will be used if the beneficiary doesn’t attend college or doesn’t need all the money saved in the 529 plan has stopped some parents from saving more or using 529 plans altogether, according to the survey. “Expanding the definition of qualified expenses to include Roth IRA transfers breaks down a common barrier to opening a 529 account in the first place,” said Mert. The new Roth-transfer option is “poised to drive growth in 529 plan usage."
Nationwide, there were more than 16 million 529 accounts in the first quarter of this year, with aggregate assets of nearly $500 billion, according to Saving for College.
Other factors besides the potential to roll over unused funds to a Roth IRA actually rank higher in influencing the decision to open a 529 account, the group said. Eighty-six percent of respondents said that “financial security for a child’s education” ranked as the top reason for opening an account. Sixty-nine percent of respondents cited the tax advantages. Only 23% indicated that the “ability to roll over funds into a Roth IRA” was their primary reason for opening a 529.
Account owners may not realize all the options available for leftover account funds, including changing beneficiaries to another child or grandchild, the survey found. Just 59% of account holders surveyed said they feel only “somewhat knowledgeable” about plan benefits. The survey found that as much as 81% of respondents who don’t have a 529 said they did not know that 529 plans can be used to pay off student loans of up to $10,000 per beneficiary. Among account holders surveyed, that number rose to 58%.
“The survey highlights the importance of continued education and outreach,” Saving for College said.
The survey also highlighted reasons why some parents and grandparents are reluctant to open a 529 plan. Of those who do not yet have a 529 plan, 32% of those surveyed said that “fees and expenses” were a concern and 26% cited worry about “investment risks.” Another 25% said their resistance was due to “uncertainty” about being able to “save enough to make it worthwhile.”
The survey of 1,133 people was conducted online from June 28 to July 10. Sixty percent of respondents were parents who were interested in saving for their child’s education and 32% were grandparents who were interested in saving for a grandchild’s education.