How Much Should You Put in Your Child’s 529 College Account? What If It’s Too Much?


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Your child is two years old. You want to save for their college. The answer to “Where should I save?” is easy enough. The bigger, harder question is: “How much should I save?”

(Even if your child is 16 years old, the question is still hard to answer.)

We work with a lot of couples with children from 0 to college age, and we get this question from pretty much every one of them. Here’s how we help our clients answer that question.

[Note: In this article, we’re talking about situations in which you can contribute more to the 529 plan if you want to. It’s another matter entirely if you simply don’t have enough money to save much to the 529.]

Why Is It So Hard to Know How Much to Save for College?

Because you have no idea how much college will cost.

If your child is two, everything is uncertain. First and foremost, no one knows how much college costs will change over the next 16 years (and it could be substantial!).

Some issues will get clearer as your child approaches college age:

  • Will your child even go to college?
  • Is your child likely to get financial aid?

But there are some issues that will likely remain pretty much just as murky:

  • What school will accept your child?
  • Which school will your child want to go to?
  • How much will it cost?
  • Will your child get any scholarships?

So, your child’s college could end up costing $0 (no college at all, full ride somewhere, or the military pays for it), $30,000/year (in-state public school), or $80,000/year (Harvard and its ilk).

529 Plans Can Be a Great Place to Save for College

529 plans are a good way to save for college because they can save you in taxes, perhaps meaningfully.

Why? Because they work more or less like a Roth 401(k) or Roth IRA. Does that comparison not help in the least? What I mean by it is this:

  1. You get no tax breaks when you put money into the 529. (Some states do provide state income tax deductions. They’re usually quite small.)
  2. As the investments grow (hopefully), you pay no taxes on any of the growth.
  3. When you sell your investments and take the money out of the 529 in order to pay for college, both your contributions and all the earnings come out tax free.

Pretty sweet! If you invest money for 18 years, that can be quite the tax savings!

…Except When You Don’t Need All the 529 Money

The downside is: If you put more money in the 529 than you need to pay for your child’s college, you can pay taxes and penalties on that excess money.

If you take money out of the 529 not for eligible education expenses, you have to pay income taxes and a 10% penalty on the earnings. (Your contributions come out tax- and penalty-free.)

That could be painful!

[Added 8/10/2023, thanks to a helpful colleague on Twitter.] There is an important exception: “If your child attends a Service Academy, you can withdraw 529 Funds based on the “Equivalent Cost”, which the Service Academy publishes annually. You avoid the penalty, though you pay taxes on the gains as ordinary income.” The same rules apply if your child gets a scholarship and that scholarship money renders the 529 money “too much.”

You still have to pay ordinary income tax on the gains. If you had invested the money in a plain ol’ taxable investment account, you’d only be paying the usually lower capital gains tax on the gains. So that’s still one count against 529s. That said, as my colleague points out, the whole reason you now have an excess of money in your 529 is: YOU DON’T HAVE TO PAY AS MUCH IN TUITION. So, on the whole, you’re a winner, darling.]

So, how do we balance getting the tax benefits of putting money into the 529, but avoiding the taxes and penalties if we put too much money in?

A Good Strategy: Put a Conservative Amount in the 529

Because we have no idea how much your child will eventually need to pay for college, I really like the idea of putting a conservative amount of money into the 529. The amount contributed will get the tax benefits, but you’re pretty sure not to save “too much” into it.

What does “conservative” mean? It’s definitely subjective, but here are some answers I like:

  • Save enough to the 529 for a lower-cost school (like an in-state school).

    Then save a bunch more in a taxable account for any remaining cost, as a backup. You can take money out of a taxable investment account at any time, with no penalty, and the tax you pay will be the capital gains tax, which is usually lower than the income tax.

    Or, if you’re high income, you can plan to pay any excess costs out of your cash flow in the college years.

  • Save roughly ⅓ of your guessed-at costs to the 529.

    This comes from advice I heard years ago from a college expert: Plan to pay college expenses ⅓ from past income, ⅓ from current income, and ⅓ from future income (which is to say ⅓ from savings, ⅓ from your paycheck, and ⅓ in loans).

Useful Ways to Deal with “Too Much Money” in Your Child’s 529

So you end up with too much money in your child’s 529 after all. There are several nice ways of dealing with this. It doesn’t have to be a “problem” at all!

The New Hotness: Kickstart Your Child’s Retirement Savings by Transferring It to their Roth IRA.

As I wrote about in this blog post about the SECURE Act 2.0, passed into law in 2022

You can convert money from the 529 (that your child is a beneficiary of) into a Roth IRA owned by your child. The excess money in the 529 can thus be transmuted from “to be used for education” to “to be used for retirement” without any penalty or tax.

Sounds great! But there are a ton of restrictions:

  • Your child has to actually earn money (as in, jobbity job) in order to put any of that 529 money into their Roth IRA in any given year. 
  • The 529 must have been maintained for 15+ years.
    If you opened the 529 around when your child was born, then by the time college is approaching, this requirement is easily satisfied.
  • Contributions made to the 529 within the previous five years can’t be moved.
  • Each year you can convert only up to the IRA contribution limit. In 2023, you would only be able to convert $6500. 
  • There’s also a lifetime cap on conversion of $35,000.

So, if you overfund by $100,000? This tactic can only help so much. But perhaps in combination with other tactics below, it can be part of a full solution.

Let your child use it for graduate school.

If your child’s college doesn’t cost as much as you have saved in the 529, they can always use the remaining money for graduate school, or even some forms of professional development (assuming that the education is provided by eligible providers). 

In this case, you don’t have to do anything. Just let the account sit and the investments continue to grow (hopefully).

Change the beneficiary on the 529.

You can change the beneficiary (the person who gets to use the money) on the 529 as often as you like. (Check out this article for more details.)

So, if there is more in the 529 than Child #1 needs for their college expenses, you can always use what they need from the 529, and then change the beneficiary to Child #2, for their college expenses. Or change it to yourself! Or you can wait until your child has a child, and change the beneficiary to your grandchild! You can change the beneficiary to many other family members also, within limits.

[Note: In what is admittedly probably a corner case, once 529 balances get really high, and you’re changing beneficiaries from one generation to the next, like from your child to your grandchild (and especially next next, like from your child to their grandchild), you could run into some estate tax and generation-skipping transfer tax challenges. If you plan to change the beneficiary from, say, your child, to your grandchild, talk with a CPA and/or estate planning attorney, and perhaps take a peek at this very detailed article about this issue.]

So, really, putting “too much” into your child’s 529 might not be much of an issue after all. For those of us who don’t have unlimited resources and still need to decide between saving for college and saving for other priorities, however, I hope you now have a better idea of how to best use 529s for your family’s specific needs.

If you want to work with a planner who can help you give your child the kind of college experience they deserve, reach out and schedule a free consultation or send us an email.

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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

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