How to Save for College Without Worrying About Saving Too Much (EP.252)

0:29We all need to make smart decisions with our money. child. And that's how much money should actually go into a 529 plan. Because 529 plans are powerful, but some families also worry about overfunding the account, locking up too much money and finding out later that their child got a scholarship or chose a less expensive path or didn't need it after all for school at all. And while the newer 529 to Roth IRA rollover rules help, those rules don't make it an obvious choice to pour every dollar you can into a 529. Instead, I think parents and grandparents need to think more intentionally about what job each account is supposed to do.

1:09Now, before we get into it, I've got a free one-page companion guide in the show notes called, Can I Make a 529 to Roth IRA Transfer? You can download that in the show notes at thelongterminvestor.com or there's a link at the top of the episode description that gives you direct access. There aren't any gates, no email is required. Hopefully this gives you a simple framework for deciding whether this strategy may apply to your family and whether those dollars may be better used elsewhere first. Now, let's start with what 529 plans do well. A 529 plan is one of the best tools we have for education savings because the earnings grow free of federal tax, and withdrawals are tax-free when used for qualified education expenses.

1:55Depending on where you live, your state may also offer a deduction or credit for the contributions. Just as important, the account owner keeps control of the assets, and the beneficiary can be changed to another family member if plans change. It's that combination of tax benefits, control, and flexibility that's really hard to beat. Now, from an investment standpoint, most plans make it pretty easy. If you're a busy parent or grandparent, age-based portfolios are often a perfectly reasonable default. They typically start with more stock exposure when the child is young and gradually become more conservative as college gets closer.

2:33It's not really complicated, and that's part of the appeal. So how much should you actually put into a 529 plan? And I think this is where a lot of people get tripped up. The tax code allows you to put quite a lot of money into a 529. And contributions, while they can have gift tax consequences if they exceed the annual exclusion amount, there is a special rule that lets you front load up to five years worth of annual exclusion gifts into a 529 and spread them ratably for gift tax purposes. So in other words, the system gives families room to fund these accounts aggressively, but just because you can contribute that much doesn't mean you should.

3:13In practice, I think many families are better off treating a 529 as a tool for funding a meaningful portion of future education costs, but in practice, I think many families are better off treating a 529 as a tool for funding a meaningful portion of future education costs, not necessarily every last dollar. If your goal is to be really helpful without boxing yourself in, aiming to cover maybe 60 to 70 % of expected tuition can be a reasonable target because that leaves room for changing circumstances or the reality that your child may not follow the exact path you pictured when they were three years old.

3:50And I also want to repeat something I've said before. You really shouldn't be prioritizing your child's education savings over your own financial well-being. Kids can always borrow for school, but you cannot borrow for retirement. I'm pretty sure that if my kids had to choose between taking out some student loans or having me live in their basement in retirement, I'm pretty sure they would choose to fund their own education. And that's what gets us to the emotional heart of the issue. Education planning is a long-distance decision made with incomplete information. When your child is young, you don't know whether they'll earn a scholarship or attend a lower-cost school or go to graduate school, pursue a trade, or leave the money unused.

4:31And for a long time, that uncertainty created a real psychological barrier. What if I overfund this account and trap the money in the wrong place? because non-qualified withdrawals generally trigger ordinary income tax on the earnings portion, plus there's an additional 10 % tax on those earnings. The good news is that 529s have always been pretty flexible. You can still use the money for other qualified education expenses, and you can even change the beneficiary to another family member. Now, in some cases, though,$529 can also be moved into a Roth IRA for the beneficiary, and that Roth rollover rule is relatively new and something that everyone seems to notice, and I get it.

5:12It sounds like a big deal, but this is not a loophole for supercharging retirement savings through a 529. I'd say at best, it's a limited safety valve for modest overfunding. The rules are tight by design, and that's why I actually think this change is so helpful. It just reduces the fear of making a reasonable mistake without turning the 529 into a stealth retirement account. So the easiest way to understand the rules is to break them down into three buckets. Who can do it, when they can do it, and how much they can do. And remember, there is a flow chart, a single page PDF that you can find in the show notes at thelongterminvestor.com or a link at the top of the episode description.

5:54Now first, who can do it? The Roth IRA has to belong to the same person who is the 529 beneficiary. And the beneficiary needs enough earned income in the year of the rollover to support the amount moved. Second, when can they do it? The 529 account generally has to have been open for at least 15 years, and the dollars being moved generally have to come from contributions and earnings that have been in the account for more than five years. The transfer also has to be done directly from the 529 to the Roth IRA custodian. You can't take possession of the money yourself and then try to redeposit it later kind of the way that you might with, say, like a 401k rollover.

6:34Third, how much can you do? The rollover counts towards the beneficiary's annual IRA contribution limit for that year, which means any other traditional or Roth IRA contribution they make uses up part of the room. There's also a lifetime cap of$35 ,000 per beneficiary. So in practice, this usually means a series of annual transfers over multiple years, not one big move. Beginning in 2026, the IRA contribution limit is$7 ,500, which shows you how this would usually play out over time. Now, here's what I think is the most important part. I'm not so sure that you should begin with the Roth rollover.

7:14I think when you have excess money in a 529 plan, you really should begin with the original goal. So before you start mentally converting education savings into retirement savings, ask whether the money is still likely to be used for education or whether another family member could use it and whether you're overlooking legitimate qualified education expenses. And this is part of why I think that PDF that I keep referencing in the show notes and at the top of the episode description is so useful because it pushes you to ask those questions before making the transfer. But if the education need is truly behind you and the beneficiary has earned income, then the rollover can be genuinely valuable.

7:55I mean, think about it. Giving a young adult an early Roth balance matters, not because the$35 ,000 solves retirement by itself. Trust me, it doesn't. But because starting early matters. And this rule gives families a way to redirect otherwise stranded education money into a long-term asset without creating an unnecessary tax hit. Now, that is a meaningful improvement. A few important cautions. There are still a couple of reasons not to get too cute with this. The first is that federal tax treatment and state tax treatment are not always the same. Some states may recapture prior deductions or credits or otherwise treat the rollover differently.

8:35Second, there are still unresolved questions about how beneficiary changes interact with the 15-year rule. So if your plan involves changing beneficiaries mainly to create rollover eligibility, slow down and get some tax advice before acting because this is one of those areas that is a little tricky. And I think that leads to the real planning takeaway here is that the answer to overfunding risk is not always avoiding 529s. I think more often it's simply avoiding the temptation to put every dollar for a child into one kind of account. And that's why custodial accounts can be useful. A custodial account, usually an UGMA or UTMA, is not a tax-advantaged education account like a 529.

9:15It's an investment account owned by the child with an adult serving as a custodian until the child reaches the age of majority under state law. Now, that means it doesn't offer the same education-specific tax benefits or the beneficiary flexibility the way that a 529 does, but it offers much broader flexibility than that because the money can generally be invested in a wider range of options. And while the child is still a minor, it can be used for a child's benefit without it having to fit inside the narrower definition of qualified education expenses. And that's why I think the custodial accounts can be a little underrated.

9:51Not necessarily because they're better than 529 plans. They usually aren't, but they can serve a different purpose. A 529 is often a better tool for core education funding, while a custodial account can be a useful sidecar account for those gray area expenses that tend to pop up around the college years or for families who want some money set aside for a child without locking every dollar into an education-only bucket. Of course, that flexibility comes with trade-offs. The gift to the child is irrevocable. You generally can't change the beneficiary the way you can with a 529. And once the child reaches the age of majority, the account becomes theirs to control, and they can use it for college or not.

10:33Custodial accounts can also be less favorable in the financial aid calculations because the UGMA and UTMA accounts are treated as student assets while a parent-owned 529 is reported with the parent's investments for a dependent student. From a tax standpoint, we also have to keep in mind that investment income in custodial accounts can run into kiddie tax rules. In 2026, the first$1 ,350 of unearned income is generally exempt from federal income tax, the next$1 ,350 is generally taxed at the child's rate, and then amounts above the$2 ,700 can be taxed at the parent's rate. So what's the bottom line here?

11:09If your goal is saving for qualified education expenses, a 529 plan is still usually the first place I'd look. The tax treatment is hard to beat, the owner keeps control, and the beneficiary rules are flexible. Plus, there's this newer Roth rollover provision that makes the account easier to use without feeling quite so boxed in. But I wouldn't necessarily max out a 529 just because the rules allow it. I think the better way is to match the account to the job. So you use your 529 for core education savings, and then you treat the 529 to Roth rollover as a backup valve, not the goal. Then you can use the custodial account when flexibility matters, and you don't want every dollar for a child locked into an education-only bucket.

11:53So again, there is a free companion PDF in the show notes at thelongterminvestor.com. You can also find it at the top of the episode description. And I think you're going to find it pretty useful for how to work through those unused$529, whether they should stay into the$529, still be used for education, or eventually move to a Roth IRA. As always, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan.

12:35All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.