Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / Why Your Child’s College Fund Is Actually a Trap
Transcript
- Lucas: Look, we spend a lot of time talking about how much you should save for college. But today, I want to talk about what happens when you save too much. Luna: That sounds counterintuitive. Isn’t having more money always better? Lucas: It is, until it triggers a cascade of negative side effects in the financial aid system. We’re seeing parents who maxed out their 529 plans realize later that those assets are being counted heavily against their child’s need-based aid eligibility. It’s not just about paying tuition; it’s about how that money interacts with federal formulas. Luna: So you’re saying the very tool meant to help might actually be hurting their chances for grants? Lucas: Exactly. The Free Application for Federal Student Aid, or FAFSA, treats parent-owned 529 balances as parental assets. While parental assets are assessed at a lower rate than student assets, they still count. And here’s the kicker: if you have multiple children in college at once, the math gets even messier because the formula doesn’t fully account for the total cost burden across siblings. Luna: Wait, so if two kids are in school simultaneously, the system doesn’t quite reflect the real strain on the household income? Lucas: Right. The half-life rule used to help, but recent changes mean that even if one child graduates, the remaining sibling’s aid calculation still sees the full weight of those saved assets. It creates a situation where you’ve paid into a tax-advantaged account, only to see your grant eligibility shrink dollar for dollar. Luna: That feels like a penalty for being responsible. Why would the government discourage saving? Lucas: It’s not designed to discourage saving per se, but to prioritize need. The logic is that if you have significant liquid assets, you should use them before asking for public funds. But that logic breaks down when those assets are locked in a 529, which isn’t truly liquid without potential tax penalties. Luna: So we’re creating a liquidity trap. You can’t easily access the money without losing some to taxes, but you also can’t use it to offset aid calculations effectively. Lucas: Precisely. And then there’s the second issue: student borrowing capacity. When colleges calculate your Expected Family Contribution, or EFC, based on high 529 balances, they assume you’ll pay more out-of-pocket. This often leads families to take on larger private student loans instead of relying on scholarships. Luna: Which means the student starts their career with more debt than necessary. That’s a long-term drag on their financial independence. Lucas: It is. And in September 2026, with interest rates hovering higher than they were five years ago, that extra debt costs significantly more. A $10,000 difference in loan principal can translate to hundreds of dollars more in monthly payments over ten years. Luna: So the goal shifts from maximizing savings to optimizing the gap between savings and aid. It’s a balancing act rather than a sprint to the finish line. Lucas: Spot on. One strategy is to stagger contributions. Instead of dumping a large sum early, you might contribute gradually as the child approaches college age. This keeps the asset balance lower during the critical FAFSA filing window. Luna: But doesn’t that risk missing out on compounding growth earlier on? If the market goes up while you’re holding back cash, aren’t you leaving money on the table? Lucas: That’s the trade-off. You have to weigh investment returns against potential aid loss. For many middle-income families, the guaranteed return from an additional Pell Grant or state scholarship often outweighs the marginal gain from extra market exposure in a 529 fund. Luna: I hadn’t considered that the best investment might actually be getting free money through grants rather than chasing percentage points in the stock market. Lucas: Absolutely. A 4 percent annual market return is nice, but a $5,000 grant has a 100 percent return because you didn’t put any effort or capital into acquiring it directly. It’s pure upside. Luna: Okay, so let’s pivot for a moment. If our money conversations have helped you think about these decisions differently, consider supporting us. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo. It helps us keep producing ad-free content that dives into these nuances without rushing. Lucas: We appreciate every bit of support. It allows us to dig deeper into topics like this, where the details matter more than the headlines. Luna: Thanks for keeping us going. Now, back to the strategy—what about using those 529 funds to pay off student loans? Lucas: This is the new frontier. Since the SECURE Act 2.0, you can now roll over up to $35,000 from a 529 plan into a Roth IRA for the beneficiary. But there’s a catch: the 529 account must have been open for at least fifteen years. Luna: So this is really for long-term planners who started saving in elementary school. It’s not a quick fix for someone whose kid is starting college next year. Lucas: Correct. But for those who qualify, it’s a powerful exit strategy. If you’ve overfunded the 529 and the child doesn’t go to college, or finishes early, you can move that money into retirement savings tax-free, avoiding the usual 10 percent penalty. Luna: That’s huge. It turns a liability into an asset. But again, it requires foresight. Most parents don’t plan that far ahead. Lucas: True. Another angle is investing in lower-cost institutions. Community colleges or state schools with strong transfer programs can drastically reduce the total amount needed from the 529. Sometimes, the smartest financial move is changing the destination, not just the deposit. Luna: So it’s not just about how much you save, but where you send them. Location matters as much as liquidity. Lucas: Exactly. And don’t forget about outside scholarships. Encouraging your child to apply for them can reduce the EFC calculation indirectly by lowering the actual cost attended. Less cost means less reliance on your savings. Luna: That’s a great point. Active involvement in the application process for grants can be just as valuable as passive saving. Lucas: It is. We often treat college funding as a solitary financial task, but it’s really a team sport involving the student, the parents, and the financial aid office. Everyone needs to play their part. Luna: Do you think the current system is broken, or is it just misunderstood? Lucas: It’s both. The rules are complex enough to confuse even experienced advisors. But the underlying principle—that education is a shared responsibility—is sound. The problem arises when we try to game the system with rigid savings products that don’t adapt to dynamic family needs. Luna: So flexibility is key. Keeping some options open rather than locking everything into a single vehicle. Lucas: Yes. Diversify your approach. Use a mix of 529 plans, taxable brokerage accounts for flexibility, and perhaps a small cash reserve for unexpected opportunities or emergencies. Luna: And never sacrifice retirement security for college. That’s the golden rule, right? Lucas: Always. No one borrows for retirement, but students can borrow for college. Protect your own future first, then figure out the best way to help theirs within those constraints. Luna: It’s a tough call, but prioritizing long-term stability usually pays off for the whole family. Lucas: Definitely. As we look toward the next academic year, the question isn’t just how much you can save, but how strategically you deploy it. What’s your plan?