Resist the Urge to Oversave in 529 College Savings Accounts

Saving more when you can is tempting, but there are risks involved.

It's tempting not to overfund your children's 529 accounts, but it's a bad idea.

529 plans are tax-advantaged investment accounts designed to pay for education expenses. Money you contribute to a 529 is taxed upfront, just like money you put into a Roth retirement account. When you withdraw funds to pay for qualified education costs, such as tuition, room and board, and laptop.  In addition, the beneficiary may spend up to $10,000 per year on K-12 education costs and up to $10,000 throughout their lifetime to pay back student loans.

Perhaps the main disadvantage of the strategy is that it may only be used on qualifying educational expenses. You'll incur a 10% penalty and income taxes on any money withdrawn from the account you don't utilize (your first contributions are not taxed).

Keep in mind that you can withdraw the value of a student's tax-free scholarship or grant and use it for any purpose without incurring a penalty. Income taxes will still be due, so you'll essentially be keeping the cash in a taxable brokerage account.

There other options for what to do with a 529 plan if the beneficiary decides to not go to college, including using it at other qualifying two-year associate degree programs, trade schools, and vocational schools, or changing the beneficiary

The solution is to set aside a portion of your college fund elsewhere, such as a taxable brokerage account. Some people maintain a college fund within a permanent life insurance policy, which typically allows you to withdraw your premiums tax- and penalty-free.

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