529 Dilemma

[Mavmoses07]

Hi, I'm starting to think that I have contributed too much to my daughter's 529 and should have instead contributed more to my retirement accounts. She's current 1 years old and her current 529 balance is $77k. Based on some rough numbers ($77 * 1.06^17 = $207k) I project her 529 balance to be in excess of $200k (assuming 6% return after inflation, all funds are in stocks now). I know college costs in the future are difficult to predict, but assuming there's no large market drop it seems that her 529 balance will exceed any amount she will need in college, especially if we do any sort of college hacking.

As I see it I have 3 options:

1. Leave things the way they are. Assuming her 529 exceeds her college costs, I'll just withdraw the excess funds and pay the penalty and taxes.
2. Withdraw a portion now and pay the penalty and taxes. Invest the withdrawn funds into my Vanguard brokerage account.
3. Invest all 529 funds into bonds and reallocate funds in my 401k and Roth to achieve my desired overall asset allocation.

I'm leaning towards Option 3. Investing in bonds in all likely hood will slow down the 529 growth, and I won't end up with a huge surplus when my daughter is ready for college, as I might with the funds all invested in stocks. This wouldn't be the best tax optimization strategy as 529 money is post-tax: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

Currently 22% of my daughter's 529 balance is earnings. As I understand it the tax on early withdrawals is 10% penalty plus income taxes on earnings. Therefore for every $1000 I withdrawal I would have to pay:

$1000*22%*(10%+28%+4.63%) = $104.
CO state tax: 4.63%
Federal tax: 28%

Plus I've received CO state income tax benefits (can deduct 529 contributions from state income tax). So $1000*(1 - 22%) * 4.63% = $36

Total tax and penalty= $140 per $1000

As I mentioned in Option 1 I could leave things they way they are now, however in 17 years if the 529 balance is far more than my daughter will need for college I'll have to pay an even greater tax on the remaining funds as a greater percent of her 529 balance at that point will be earnings (however if I'm retired at that point our income tax bracket will be less). Thoughts?

[Morning Glory]

Take option 1. You can transfer the unused funds to another beneficiary, such as a niece, nephew, grandchild, or even yourself.

[bas5252]

As the parent of 2 college-aged kids, I would agree with the PP that you should go with option 1.  To know that your child's college is funded is a nice worry that you will not have to deal with in the next 17 years.  Remember that the funds in the 529 can be used for a variety of college-related expenses.  Do they need to computer for college?  That will be covered with the 529 funds.  Any special software? Covered.  Even off-campus housing is covered as long as they are a half-time student.  Plus, at my son's college, there is an off-campus meal plan that I can also pay for with 529 funds.  And, if you want your kid to pay for part of their college with their own funds, you can still pay with 529 funds and have them pay you back instead of directly paying the school.  That way you both get a tax break.  Through careful investing and saving and the kids working while in high school and summers, both my kids will graduate college with zero student debt, and I think that is a wonderful graduation gift for any college graduate.

[Paul der Krake]

I wouldn't preemptively sell 529 assets. Your daughter could decide to go to an expensive school, or medical school, or be on a 6-year plan, or any combination thereof. Or maybe she'll get a surprise sibling.

In the absolute worst case scenario, could you make someone else's child the beneficiary, pay some expenses out of the 529 and they pay you back? You would have to be mindful of not running afoul of gift laws and finding a trustworthy family to make this work though.