Why Saving Too Much Money for a College Fund Is a Bad Idea

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If you have children, you may have a 529 education savings plan set up. While it's helpful to save for your kid's college education in advance, there are downsides to saving too much. Here are a few reasons you may want to adjust your contributions and/or revise your college fund strategy.

1. You may make more financial sacrifices than necessary

Unless you're loaded, you're probably making concessions elsewhere in your budget to keep up with contributions to your 529 — but at what cost? Are you neglecting other necessary payments, like credit card debt, resulting in additional fees? Are you compromising your health by reducing your visits to care providers? Do you have a sufficient emergency fund?

Saving for your child's college education is important, but don't put it before any immediate needs. Paid-in-full college tuition is a luxury and privilege, and it shouldn't be your top priority if other aspects of your personal life and finances are affected.

2. Your retirement fund will suffer

If you're putting your child's paid-in-full education before your own later-in-life needs, consider this: You can take out a loan for education, but you can't take a loan for retirement. Millions of students have furthered their educations on their own dime and lived to tell the tale, because they're in perfect condition to work it off after they're spit out into the real world. You, however, may be nearing the time when you may not want or physically be able to work as your kid goes off to school, and that could wreak havoc on your financial future.

"If you devote the majority of your family savings to fund college education out of pocket, be prepared to push out your retirement goals," says registered investment adviser Ryan Miyamoto. "By the time you are starting your family, you are usually thinking about getting serious with your retirement savings as well. These goals end up competing with each other, and with the rapid cost of college education, your retirement will suffer."

3. You're missing out on tax-exempt withdrawals of your 529 plan

Conservative investors miss out on the biggest benefit of 529 savings plans — tax-exempt withdrawals. Since tax-exempt withdrawals are only applicable to the gains, if you're using a 529 account to save for college and invest conservatively, your gains will be minimized compared to a growth investor. Having education as a top priority adds fuel to the fire of being conservative; you don't feel like this is your money, but rather your kids', so you irrationally think you want to minimize losses.

Adds Miyamoto, "Conversely, if these same individuals were to invest their savings into their own 401(k), the mentality changes; they're willing to take more risk since they view it as their own money."

4. You will have to pay sizable penalties if your 529 isn't used

You probably have an idea of how much you need to save for your child's education when you open your 529 plan, but whatever that number, it's still just a rough estimate. Your kid may need more than what you think college may cost at his or her time of birth, based on inflation 18 years later plus their choice of college. Let's hope the latter doesn't break the budget — but it probably will.

On the other hand, if you funnel too much money to the account and it goes unused — for instance, if your scholar attends a relatively inexpensive school (which is normally good news, but not in this case) or decides not to attend college at all — you're going to kick yourself for not being a little more selfish with your money.

"If you overload a particular savings vehicle for college, you run the risk of actually being financially penalized," explains certified financial planner Greg Knight. "For example, if you save too much in a 529 savings plan without having a drawdown strategy, you will incur income tax and a 10 percent penalty on the earnings portion of withdrawals not used for qualified education expenses. In general, distributions from 529 plans are not taxed provided they are used for qualified educational expenses. However, if you have paid all expenses and still have funds left, as the parent account owner you need to either name yourself as beneficiary and attend a qualified educational program to use the funds tax-free, or have another child or grandchild to name as a beneficiary."

With 529 distributions, a portion is tax-free (as basis) and a portion is taxable (as earnings) unless the distribution is used to pay qualified educational expenses. Without knowing in advance who will use the 529 funds until they are depleted, you run the risk of paying tax and a 10 percent penalty.

5. You don't know if your kid will go to college

Another issue with putting too much cash in one basket is the variable of whether or not your kid will go to college at all. Once they're 18, you can't really make them do anything (unless you're holding financial support over their head), and, let's face it: College isn't for everyone. Having this fund might place undue pressure for them to do something they don't really want to do.

6. Your kid might not appreciate your sacrifice

I'm not suggesting that you shouldn't save for your kid's college education, but perhaps you shouldn't foot the entire bill. At the very least, refrain from telling them how much money is actually available. Plenty of parents want to pay their kids' way through college so they can enjoy the full experience, but that's really just providing them with an excuse to avoid taking on adult financial responsibilities. They may not truly appreciate the value of their education (nor your many years of saving) if they don't have to work for at least part of it themselves.