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Paying for school is among the biggest financial mountains families need to climb. An uncommon few diligent savers finish up in the surprising position of having more money saved than they absolutely need.
There are lots of reasons parents and grandparents find themselves with too much money saved for a youngster’s college costs. They range in the happy (a student gets to be a generous scholarship) to the tragic (the student dies before reaching college age). Additionally, the little one decides to not go to college in the end.
The most widely used vehicle for school saving may be the 529 plan, a kind 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 primary benefit from these plans is that any investment gains are tax-free when the money is employed for qualifying educational expenses for example tuition, room and board.
There’s a 10% penalty for withdrawing funds from a 529 plan for something apart from college costs, so it’s vital that you be strategic if there’s a good reason to use the money for purposes apart from advanced schooling. Paul Curley, director of school savings research at Strategic Insight, an industry research company in Boston, says about 10% of distributions from 529 plans aren’t used for qualifying expenses.
If you choose excess funds inside a 529 plan, there are many choices for managing the money responsibly.
Don’t touch it
“Doing there is nothing a choice,” says Chad Nehring, a financial advisor at Conceptual Financial Planning in Appleton, Wisconsin. “You can literally leave the funds wallow in it to have an infinite period of time if you desired to.”
The advantage of leaving the funds within the account is you can decide later ways to use the money. Probably the student will eventually pursue an advanced degree, and also the money that were saved for undergraduate education can defray the price of graduate school. If the money is still sitting there when the student’s own youngsters are ready for college, the money may be used to setup funds for them.
Change the beneficiary
“More commonly, we have seen a transfer to another beneficiary,” Nehring says. Beneficiary changes can be made annually, there can be just one beneficiary allotted to the account at any given time. There aren’t any tax consequences as long as the brand new beneficiary is really a family member, based on the IRS. In families with multiple children, it isn’t uncommon for resources that weren’t required for an older child to be used in a sibling. Nehring advises that the money be saved for the next generation whether it isn’t needed immediately. If the money was saved through the student’s parents, they might like the idea of preparing well ahead of time to fund their grandchildren’s educations.
Pay the penalty
Whether withdrawing funds early because of financial hardship or repurposing the cash for retirement after the kids are grown, there are situations where while using cash for non-college expenses seems reasonable. Eda Kauffman, a social worker in Philadelphia, seized a chance to take her daughters to Southeast Asia for three months when her husband, a teacher, was granted a sabbatical. They decided the need for the trip was significant enough to warrant raiding the girls’ college accounts.
“We saw it as a real educational experience,” Kauffman says. “We decided to pull money out. There was a small penalty, however it was worthwhile.”
A rare occurrence
The quantity of families that end up with too much saved for school is incredibly 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 total amount a student might need to borrow, and money in a 529 plan’s treated more favorably in financial aid calculations than funds held in less restrictive accounts.
For his own 2-year-old daughter, Curley is putting $25 a month inside a 529 plan. “People need to consider their choices,” he states. “Twenty-five dollars per month is tough but doable for most families. Every single dollar makes a difference.”
Virginia C. McGuire is really a staff writer covering personal finance for NerdWallet. Follow her on Twitter @vcmcguire and on Google+.
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