Paying for college is one of the biggest financial mountains families have to climb. A rare few diligent savers find themselves in the surprising position of having more money saved than they actually need.
There are plenty of reasons parents and grandparents find themselves with too much money saved for a youngster’s college costs. They range from the happy (the student receives a generous scholarship) to the tragic (the student dies before reaching college age). More commonly, the kid decides not to go to college after all.
The most popular vehicle for college saving is the 529 plan, a type of investment account named after the section of the federal tax code that created it. Although contributions aren’t deductible on your federal tax return, some states allow them to be made with pretax money. The main benefit from these plans is that any investment gains are tax-free if the money is used for qualifying educational expenses such as tuition, room and board.
There’s a 10% penalty for withdrawing funds from a 529 plan for something other than college costs, so it’s important to be strategic if there’s a good reason to use the money for purposes other than higher education. Paul Curley, director of college savings research at Strategic Insight, a market research company in Boston, says about 10% of distributions from 529 plans aren’t used for qualifying expenses.
If you end up with excess funds in a 529 plan, there are several options for managing the money responsibly.
Don’t touch it
“Doing nothing is an option,” says Chad Nehring, a financial advisor at Conceptual Financial Planning in Appleton, Wisconsin. “You can literally leave the funds sit there for an infinite amount of time if you wanted to.”
The advantage of leaving the funds in the account is that you can decide later how to use the money. Perhaps the student will eventually pursue an advanced degree, and the money that had been saved for his or her undergraduate education can defray the cost of graduate school. If the money is still sitting there when the student’s own children are ready for college, the money can be used to set up funds for them.
Change the beneficiary
“More commonly, we see a transfer to another beneficiary,” Nehring says. Beneficiary changes can be made once a year, and there can be only one beneficiary assigned to the account at a time. There are no tax consequences as long as the new beneficiary is a family member, according to the IRS. In families with multiple children, it’s not uncommon for resources that weren’t needed for an older child to be transferred to a sibling. Nehring advises that the money be saved for the next generation if it isn’t needed immediately. If the money was saved by the student’s parents, they might like the idea of preparing well in advance to fund their grandchildren’s educations.
Pay the penalty
Whether withdrawing funds early because of financial hardship or repurposing the money for retirement after the kids are grown, there are situations where using the cash for non-college expenses seems reasonable. Eda Kauffman, a social worker in Philadelphia, seized an opportunity to take her daughters to Southeast Asia for three months when her husband, a teacher, was granted a sabbatical. They decided the value of the trip was significant enough to justify raiding the girls’ college accounts.
“We saw it as a real educational experience,” Kauffman says. “We made a decision to pull money out. There was a slight penalty, but it was worth it.”
A rare occurrence
The number of families that end up with too much saved for college is extremely small. Curley estimates that 0.1% of families over-save. The possibility of accumulating a surplus shouldn’t discourage saving in the first place, he says. Saving money lowers the amount the student may need to borrow, and money in a 529 plan is treated more favorably in financial aid calculations than funds kept in less restrictive accounts.
For his own 2-year-old daughter, Curley is putting $25 a month in a 529 plan. “People need to think about their choices,” he says. “Twenty-five dollars a month is difficult but doable for most families. Every single dollar makes a difference.”
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