Save Too Much for College?

Full Transcript:

What happens if I save too much for college?

Many of my clients are or will pay for some or all of their children’s college expenses. Now, we all know that college is expensive. However, some people are actually worried that they’ll save too much money for their children’s education. Let’s talk about what happens if you over-fund a 529 account.

First, let’s start with a few basics. A 529 account is a tax-advantaged college savings account. So, with this 529 account, you put money in after it’s been taxed on the federal level, but then it grows tax-deferred and can be used tax-free for qualified educational expenses. Now, in Texas, there’s no state income tax, so there is zero upfront tax deduction for a 529 contribution. However, if you live in a state with a state income tax, please ensure that you’re checking with your financial advisor or tax advisor on your specific situation.

Now, let’s assume with this 529 account that you’ve contributed, and it’s grown to $150,000 for Little Johnny’s college education. Now, let’s assume that Johnny is expected to now only need $120,000 for college. So, now you’re going to have an extra $30,000 in this account. Now, if you pulled the money out without going to a qualified expense, you would be hit with a 10% penalty and taxes on the gains. So, that is not the preferred way to get this money out. Let’s talk about some contingency options for this other $30,000.

First, if Johnny is currently in private high school, you can pull $10,000 out per year per child for private high school and for private elementary education.

Now, in addition to that, let’s assume that there’s a $30,000 gap because Johnny got some scholarships. When you get a scholarship, you can pull the equivalent amount out of the scholarship, out of the account for the scholarship. And that is going to be penalty-free. However, in this case, you will generally have to pay taxes on that gain, but you get it out without a penalty. So, this is not a bad option because it would be similar to just investing in a normal taxable account.

Now, in addition to that, make sure you’re looking at all qualified expenses. So, with a 529 account, you can use it to reimburse yourself or pay directly for tuition. But it can also be used for room, board, books, and other supplies. So, make sure that you’re looking at the full list of your expenses and comparing that with the plan rules.

Now, in addition to all this, there is a newer contingency plan that does have a lot of complexities with it, but it’s worth mentioning here. I will do a full separate video on this, and that is transferring some of this fund to Johnny’s Roth IRA.

As you can see, there’s a good amount of options to get this money out. Lastly, one of my favorite things to do is take the college fund and then change the beneficiary. So, by changing the beneficiary, it can go to Little Johnny’s siblings. Or you can leave it in there, and then it can be used for your grandchildren, little Johnny’s children, in decades to come.

Now, as you can see, there’s a lot of options for using a 529 if you’ve put more money in than your child will use. Please consult with your financial advisor on which options are best in your specific situation. Also, please continue to like these videos on social media and share them with your colleagues.