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Can You Save TOO Much in a 529?

Nov 10th, 2021 • Damian Dunn

I never hear anyone discuss the implications of saving TOO much in a 529 for your child’s college. How do you know if you’re saving too much? And if you’re on target to hit your child’s goal before age 16, should you stop making contributions even if your state (IL) provides a tax benefit up to 20K per year? Should you switch the plan to cash at that point to avoid making more gains until you need it in 2-5 years? I am wondering if directing funds elsewhere such as a taxable account might make more sense when you hit your goals in a 529.

Thanks for all that you do!

Diane


Hi Diane,

My favorite part about your question is that you already have goals in place and are actively working towards achieving them. The majority of us will be satisfied with saying, “I’m going to save for my child’s future college expenses,” and leaving it there. Are we talking about saving $10 a week? A month? A year?! Leaving too much wiggle room by using an unspecified goal sets you up for disappointment and/or complete failure. 

Enough about that. Let’s answer the questions.

How do you know if you’re saving too much into a 529? First, are you on track to meet your goal? You’ve indicated that you are, so congratulations. Over contributing to a 529, unless you’re comfortable leaving the money in the account to fund a possible graduate degree, provide money for a future grandchild, or maybe use for yourself someday, isn’t really a great idea. I do want to say, however, over-contributing by a few hundred dollars or possibly even a few thousand dollars shouldn’t be considered a big mistake. The penalty and taxes on a small remaining balance will most likely seem tolerable should you choose to withdraw the funds for non-qualified purposes. If we’re talking about saving and over-funding in the tens of thousands of dollars, though… That means it’s certainly time to look at other saving options. Non-qualified investment accounts don’t have any restrictions on what the money can be used for or any penalties associated with them. You will be taxed as you go and be subject to capital gains taxes as well as being taxed on your interest and dividends. Roth IRAs are popular vehicles for saving, too. You’ll always be able to remove the contributions you made to the account for any purpose. Is there a possibility that you’ll miss out on the state tax break? Yeah. It’s not the end of the world for most people, though. If you work with a CPA or tax preparer, you should probably run this by them to make sure you aren’t inadvertently creating some unplanned issues for yourself next filing season, though. 

Regarding your question about the allocation of your funds, that’s entirely up to you. It is a common practice to move your investments to a more conservative allocation (potentially cash as you suggested) as the time the funds are needed draw near. That approach makes sense as you don’t want the entire account subject to potentially big swings in value when you need it. Plus, if the account is funded to the level you need it to be and you’re worried about having money left over, what’s the point of taking unnecessary risk by leaving the money invested? 

Great job preparing, Diane. If you’re on target with your saving and will have everything funded early, you’re squarely in the driver’s seat and get to make the decision you’re comfortable with. 

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