Many Families Start Saving Too Late
Many families wait too long to open 529 college savings accounts. As a result, they miss out on the accounts’ maximum benefits, a new analysis finds. On average, families open 529 accounts for children who are just over 7 years old, according to Morningstar’s annual review of state-sponsored plans.
This late start leaves only about a decade to save and let earnings compound, said Madeline Hume, lead research analyst for 529s at Morningstar. The company’s analysis covered plans holding about 97% of 529 account assets.
How 529 Accounts Work
529 accounts, named after a section of the federal tax code, grow tax-free. Withdrawals are also tax-free when spent on eligible expenses, such as:
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Tuition and fees
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Housing and meal plans
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Books and equipment
Since 2018, families can also use up to $10,000 per year from a 529 plan to pay for private school, from elementary through high school. Families who wait until age 7 miss out on early, more aggressive growth years. Each year they delay reduces the growth potential of their savings, which could affect long-term retirement and education planning.
Age-Based Investment Portfolios
Most 529 plans use age-based investment options, shifting funds from stocks to bonds as the child ages. These plans assume college savers will invest from birth until age 18.
Early on, portfolios invest heavily in stocks, which are more volatile but have higher long-term growth potential. At birth, age-based portfolios typically hold 83% in stocks. By age 7, this drops to 67%, and by age 18, to 14.7%.
Families who wait until age 7 miss out on the early, more aggressive growth years. Each year they delay reduces the growth potential of their savings.
The Impact of Starting Earlier
Starting just one year earlier can make a significant difference, according to a model that Morningstar based on average allocations for stocks and bonds in age-based portfolios. Assuming a $50,000 investment, divided into equal monthly installments, someone who began saving when the child was 7 could expect a median balance of almost $81,000 by the time the child turned 18. With a start at age 6, the median balance would be almost $4,000 higher. It could be about $30,000 higher if the account had been opened at birth. (The model used historical index fund returns, and doesn’t factor in investment fees. Early contributions give families more time to ride out market swings and maximize compounding growth, which aligns with strategies for long-term portfolio growth.
Why Families Delay
So why don’t more people open the accounts sooner? Part of the reason may be that people are simply unfamiliar with 529 plans, Ms. Hume said. Research conducted for the College Savings Plans Network, a group that promotes the accounts, found that even though they had been around for more than 20 years, only about a third of Americans had heard of them.
Another factor, Ms. Hume said, may be confusion about how a 529 account affects a student’s chance of receiving need-based financial aid.
The effect depends on who owns the account. Student aid experts say the effect is generally minimal when a parent owns the account for the benefit of a dependent student. The impact can be significant, however, if a grandparent owns the account — but there are several workarounds, said Mark Kantrowitz, publisher of Savingforcollege.com.
Time Is Your Greatest Asset
Parents who wait until their child is 7 to start saving, he said, will have to save much more out of their own pocket to reach their goal.
“Your greatest asset as a parent is time,” Mr. Kantrowitz said.
In fact, he said, parents can open an account even before a child is born, naming themselves as a beneficiary and then changing the beneficiary to the child’s name after birth. Mr. Kantrowitz said he had done that for his children.
As with any investment, gains are not guaranteed. But by starting early, investors have more time to ride out the inevitable market swings. Some age-based portfolios have more aggressive tracks than others, however, so savers should make sure to check their plan’s details to be sure they are comfortable with the mix of investments as their child approaches college. If you can’t stomach the idea of losing money, many 529s offer lower-risk — and lower-return — options, including savings accounts insured by the Federal Deposit Insurance Corporation and certificates of deposit.
Saving has become more essential as the cost of college has increased and the burden of student debt has become more of a concern.
The average published cost of tuition, housing and meals is about $22,000 a year for in-state students at public four-year colleges, and about $50,000 for private, nonprofit four-year colleges, according to the College Board. (The totals don’t include fees and expenses like books and equipment.)
Here are some questions and answers about 529 college savings accounts:
How much do I need to invest to open a 529 plan?
Minimums vary, but some plans can be opened without any initial contribution, and continuing contributions can be as low as $10 per month, according to the College Savings Plans Network, which offers a comparison tool.
Do I have to invest in the 529 plan in the state where I live?
No. You can invest in any plan — but there may be tax benefits to investing in your state’s plan. While there is no federal tax deduction for 529 contributions, many states offer a deduction on state income-tax returns. And some offer a state tax deduction even if you open the account in another state.
Do employers offer help with college savings?
More employers are starting to include college savings help as one of their benefits, but it’s not widespread. Eleven percent of employers offered payroll deductions for 529 plans, according to 2019 survey by the Society for Human Resource Management.
Some companies offer 529 perks as rewards. Alliance Data in Columbus, Ohio, added Gift of College gift cards this year to a menu of rewards that employees can choose from when redeeming points earned in a workplace recognition program, said Deanna Allison, the company’s financial benefits manager. Employees like the cards, she said, because they can use them to make contributions that go directly to the 529 account.
Gift of College, a website that lets friends and families contribute online to 529 accounts, offers 529 gift cards at stores as well as through employers.
FAQs
1. What is a 529 college savings plan?
A 529 plan is a tax‑advantaged savings account designed to help families pay for education costs. Contributions grow tax‑free, and withdrawals aren’t taxed when used for qualified expenses like tuition, housing, and books.
2. How do 529 plans affect financial aid?
A 529 plan generally has only a small impact on federal financial aid. When owned by a parent, only up to about 5–6% of the account value is counted in FAFSA calculations, which usually has a minimal effect compared to income.
3. What expenses can I pay with a 529 plan?
You can use 529 funds for qualified education costs such as tuition, fees, books, supplies, and room and board. Recent rules also allow use for K‑12 tuition (up to annual limits) and student loan repayments in some cases.
4. Can I open a 529 plan at any age?
Yes. You can open a 529 plan before a child is born or at any age, but starting earlier gives more time for growth through compounding returns. Waiting until later—like age 7—means missing out on higher growth years. (This concept is illustrated in your article’s discussion.)
5. Do I have to use my home state’s 529 plan?
No. Families can choose any state’s 529 plan, but some states offer state tax deductions or credits when you use your own state’s plan.
6. What happens if my child doesn’t go to college?
If the beneficiary doesn’t use all the money, you can change the beneficiary to another family member or even use the funds yourself for future qualifying education.
7. Are there penalties if I use the money for non‑education expenses?
Yes. If you withdraw 529 funds for non‑qualified expenses, you’ll typically pay income tax on earnings plus a 10% penalty. This makes planning and qualifying uses important.
8. Is there a minimum to open a 529 account?
Minimum initial contribution amounts vary by plan. Some plans allow accounts to be opened with small amounts, and you can set up automatic monthly contributions to build savings over time.
9. Can grandparents or others contribute to a 529 plan?
Yes. Grandparents, friends, or anyone can contribute to a beneficiary’s 529 plan. These gifts can be a helpful way to boost savings, especially with tools like gift cards or payroll deductions.
10. Can a 529 plan help reduce college debt?
Using 529 savings for tuition, books, and other qualified costs can reduce how much you need to borrow. Some plans also allow up to $10,000 for student loan repayments per beneficiary.
