I Thought I Was Done Funding My Kids’ 529 Plans. A Recent Positive Change Has Me Rethinking That

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I don’t want to overfund my kids’ 529 plans. But read on to see why I may be less likely to do that if I put more money in. 

Saving for my kids’ college education is important to me. I graduated college owing money despite having worked throughout my studies, and if possible, I’d like to give my kids the opportunity to avoid that same scenario.

I’ve been putting money into different accounts earmarked for my kids’ college. A portion of their college fund is in 529 plans, and the rest is in a regular brokerage account.

The upside of the 529 plan is that investments in that account get to grow tax-free, and withdrawals used for qualified education expenses are tax-free. I’m not getting any tax benefits from my regular brokerage account, but I get flexibility.

See, the risk of funding a 529 plan is that if you end up with excess money and you withdraw it for non-educational purposes, you risk getting penalized on the gains portion of that withdrawal (not your principal, since contributions to a 529 go in on an after-tax basis). With a regular brokerage account, there are no restrictions. If my kids all decide they don’t want to go to college, I can keep that money for myself and use it to pay for retirement expenses, a new house, or anything at all that I want.

But recently, the rules changed about excess funds in a 529 plan. And so while I thought I was done funding my kids’ 529 plans, I’m starting to rethink that.

More flexibility with your extra money

Let’s be very clear. If you end up in a situation where you have more money in your 529 plan than you need for your kids’ college, you’re in a good spot. It’s far better than the opposite — saving diligently but still not having enough money to cover your kids’ college expenses in full.

But having extra money in a 529 plan can still be annoying, because you’ll face penalties on non-educational withdrawals. And while you are allowed to change your 529 plan beneficiary, that may not be enough to use up your extra money (and it may not be a viable option if, say, you only have one child).

It’s for this reason that I’ve made a point to only house a small portion of my kids’ college savings in a 529. Should they decide not to go to college or end up getting a cheap education, I don’t want to have to scramble to find a way to avoid penalties.

Recently, however, the rules of 529 plans were updated to allow you to roll up to $35,000 in excess 529 funds over to a Roth IRA without penalty. And that’s a game-changer.

Let’s say you have one child and manage to save $150,000 in their 529 plan, but they only end up needing $120,000 for their college costs. Normally, you’d either have to find a new beneficiary for that remaining $30,000 or face a penalty on the gains portion of that sum. But now, there’s a better solution. You can simply roll that $30,000 into a Roth IRA for your child so that money is reserved for their retirement.

Is a 529 plan right for you?

Even with this change, some people might still be hesitant to save for college in a 529 plan. And if sticking to a regular brokerage account is more in your comfort zone, so be it.

But it does pay to consider a 529 plan in light of this change — especially if your previous hesitation stemmed from wanting to avoid a penalty. It’s still a good idea to split your college savings between a 529 plan and a regular brokerage account like I do so you have more options. But this way, you can enjoy tax-free growth on some of your money.

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