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WE HAVE A PROBLEM: We may have saved too much for our daughter’s college education.
My wife and I started contributing aggressively to our daughter’s 529 college savings account as soon as she was born. For the first two years, we invested the full amount of the annual gift-tax exclusion, which was then $14,000. Now, the exclusion is at $16,000, but lately we haven’t been saving as much as we used to. The reason: Our early aggressive saving, coupled with gifts from relatives, mean the account can already cover a couple of years of in-state college tuition—and our daughter is only five.
You may be asking yourself, “How is that a bad thing?” The simple answer is, we could have done any number of other useful things with the money. For example, we could have used it to save more for retirement. There’s plenty of financial aid available to help students pay for college—loans, grants, scholarships, work-study—but no such thing as financial aid for retirement. Unless retirees opt for, say, a reverse mortgage, they can’t take out a loan because they didn’t save enough in their 401(k). That’s why experts say you should always make retirement savings your top financial priority, even at the expense of your kid’s college account or your homeownership dreams.
For our daughter’s college savings, we could have used another financial vehicle, such as a Roth IRA or a custodial account set up under the Uniform Transfers to Minors Act. That way, we would have had more flexiblility in how we use the money. With a 529, if we don’t use the account for qualified education expenses, we’ll face income taxes on the withdrawals, plus a hefty 10% tax penalty.
So why did we do it? Why were we so worried about paying for college? Because of my personal experience.
To pay for college expenses, I had stocks left to me by my grandparents. That helped my parents and me cover college costs without taking on student loans. It was a wonderful gift that I’ll always appreciate—and it’s one I’d like to give to our children as well.
Our children’s education is one of our family’s most important financial goals. We wanted to make sure we were on track early. We’ve now met that goal. Even if the market only returns 4% per year between now and when our daughter graduates high school, we should be able to pay the full cost of college with her 529 savings. On top of that, if we continue to save more than we need or our investments perform better than expected, the 529 can always be used for the education of future grandchildren.
Still, looking back, maybe investing so heavily in a 529 wasn’t the optimal decision. But not having to worry about one of our most important financial goals has lifted a weight off our shoulders.
If you find yourself in the same boat as us, and you saved too much for a financial goal, my advice is to stop worrying about the choices you made. Instead, be happy that you’ll achieve your goal. Let’s face it: It’s better than the alternative.
Charlie Schafer is an aerospace engineer with an interest in personal finance and investing. His other hobbies include reading widely and homebrewing beer. Charlie lives with his wife and two children in South Philadelphia.
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Good article, thanks.
We went the Education IRA route to keep fees down and have more flexibility. At the time we started, we didn’t realize that withdrawals would also be simpler too.
The bigger problem for me would be the fees. It turns out that those accounts are some of the most expensive, most restrictive options for saving. When I did some analysis a few years back, the best choice was Ohio’s funds (529 plans are contracted out by each state.) But to get into those funds and get my state income tax deduction, I would first have to use the plan in my state, then later transfer the funds.
Finally I asked myself when would be the best time to put money into those funds if I needed them. After running more numbers, the answer was the last possible year or years before my target beneficiary used the money.
If I ever get rich enough to benefit from a 529, I won’t need it. It will just be one more luxury in the tax code for someone who already lives a life of privilege.
In the meantime, there are roth IRAs, HSAs, 401ks, 403bs, and lower long term capital gains tax rates, all usually better ways to save for college and everything else.
Similar situation, but in a Coverdell account, aka Education IRA. Daughter turning 30 later this year, and her college education was taken care of by her 529. Coverdell is a two comma account…first world problem, for sure.
I applaud your decision to help fund your daughter’s education via a 529 plan. I have also read a wonderful blog penned by Jeffery Levine at team Kitces which is an in depth analysis of what he refers to as dynasty 529 plans. I commend reading that blog to anyone who is concerned about an over funded 529 plan. The article can be found at https://www.kitces.com/blog/using-a-family-dynasty-529-plan-for-multigenerational-college-planning/
If you have any leftover 529 funds after your children are done with higher education, reset the allocation to aggressive, and let it grow. In the likely event your children have children, you can simply change the beneficiary from your child to the grandchild. Who knows, maybe there will be enough leftover to pay for two generations of higher ed.
I have a friend who’s son had a fully funded 529 plan. He’s a bright kid and received a full academic scholarship to university. My friend then was able to pull the 529 money to buy a rental property in the city of the university for his “housing” and put it in his son’s name. He has roommates and is cash flowing while being paid to go to school. I’m impressed!
This is an all too common problem (but admittedly, a nice one to have). I have publicly advocated and lobbied for excess 529 funds being allowed an additional benefit for the account owner: a change in the tax code permitting for a tax-deductible charitable distribution of either a portion or all of the remaining 529 account balance (after the covered dependent has completed their formal education) to a qualified 501(c)3 educational institution.
The amount of “later” or “never” 529 money that this would unleash for higher education is staggering, with a tax-deduction for the individual making it a win-win scenario. Sadly, Uncle Sam also needs to win financially.
It would take an extremely “forward-thinking” tax advocate in D.C. to somehow monetize the “greater good” benefit for all taxpayers of more private donation dollars being directed toward higher education before such a tax-law change could ever become a reality. This change might also help mitigate some of the ever-growing student loan debt-load by putting private education dollars to work instead of ever-growing tax-payer subsidized student loan debt that will be subject to default risk or loan forgiveness, all at the expense of the taxpayer.
That would be amazing! And practical! And help the economy!
(Which means it will never happen)
While it’s true retirement savings is a priority, I’m not sure I see a problem. Maybe your daughter will aim higher than a state school, maybe she will go to graduate school, could there be another child? And, of course, there are 13 years of college tuition inflation ahead. Are you sure you saved too much?
In any case it appears you have a number of years to retirement and with your disciplined savings habits I’m betting you will do just fine.
Well our 5 year old is already playing 14y+ strategy board games with us, so I might in store to help pay for a PhD, who knows?
Just happy knowing we’re in a good position to pay off a bachelors is good enough for now. The animal spirits of the market will decide the rest.