Why It’s Never Too Late To Start a 529 Plan (and How To Catch Up)

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Kathryn Flynn

By Kathryn Flynn

March 21, 2024

529 plan advertisements are usually geared toward families with new babies since starting early is always the best time to begin. But, the reality is that many families get a late start on saving for college.

Parents who open a 529 plan when their child is a high school freshman or later can still take advantage of the federal (and sometimes state) tax benefits, even if college is just a few years away. Any college savings will reduce the child’s future student loan debt.

How 529 plans work

529 plans work similar to a Roth IRA. An individual makes contributions with after-tax dollars, which are invested in mutual funds, ETFs, or other diversified investments. The investments grow tax-deferred, and distributions are tax-free when used to pay for qualified higher education expenses.

The sooner parents start saving in a 529 plan, the more time they have to take advantage of tax-free compounding. However, there are still benefits to investing in a 529 plan, even if the beneficiary is in middle school or high school.

If you save $300 every month in a 529 plan for the next four years, the total college savings will be over $15,000. This is assuming that the funds are invested in a conservative portfolio with a 2% annual investment return. It’s worth noting that this is a fairly conservative return assumption.

Assuming a 7% rate of return, investing in a 529 plan would result in $16,659 in college savings, compared to $14,450 with an average savings account, resulting in a balance of $2,209 higher.

Selecting appropriate 529 plan investments

When selecting a 529 plan investment portfolio, parents of older children should keep their equity allocation at around 20% to 30%. Equity allocation is the percentage invested in stocks and mutual stock funds. The rest of the portfolio should be invested in conservative investments with a lower risk of loss. These include fixed-income options, such as bonds, CDs, money market funds, and FDIC-insured investments.

With only a few years until college, families might not have enough time to recoup their losses if the stock market drops.

State income tax benefits function like a discount on tuition

Many states offer a state income tax deduction or tax credit for 529 plan contributions. For parents with a shorter time horizon, a state income tax benefit can operate like a discount on college tuition. In most states, taxpayers can contribute, immediately withdraw funds to pay for college, and still claim the state income tax benefit.

However, four states block this loophole. Michigan and Minnesota base their state income tax benefits on annual contributions net of distributions. Taxpayers in these states must hold the funds in their 529 plan account for at least one year before distribution to pay for college. Montana recaptures the state income tax deduction when withdrawals are made within three years of opening the 529 plan account. In Wisconsin, tax benefits are subject to recapture if funds are distributed within 365 days of the contribution. 

Sometimes, there is a tradeoff between state tax breaks for an in-state 529 plan and lower fees for an out-of-state 529 plan. However, when the child enrolls in high school, the balance shifts to a preference that favors the state income tax benefit.

Boost college savings in the short-term

Families should consider saving one-third of total projected future college costs and covering the remaining two-thirds with current income and student loans. But, it can be difficult to save that much when a child is already 12 or 13 years old. Families who use a college savings calculator might get sticker shock when they realize how much they need to save in such a short time.

Instead, just save what you can. Every dollar you save is a dollar less you’ll have to borrow. Don’t let the high cost of a college education overwhelm you.

Families who have trouble saving at least one-third of total college costs may consider one of the following ways to boost their 529 plan savings:

  • Apply for scholarships – Scholarships for middle school or high school students are sometimes awarded as 529 plan contributions, allowing students the added benefits of tax savings and compounding. Read our Complete Guide to Scholarships.
  • Earn cash back for college with Upromise – Upromise is a free loyalty program that allows parents and grandparents to earn rewards by shopping online, booking travel, dining out, and using the Upromise Mastercard. Rewards can be automatically swept into a linked 529 plan account. Members are automatically enrolled in monthly sweepstakes to win a $529 scholarship.
  • Enlist the help of friends and family – Anyone can contribute to a child’s college savings plan. Many 529 plans have gifting platforms that make it easy for grandparents and family members to make a one-time or recurring electronic contribution. Backer is an app that allows you to link your 529 plan and easily receive gifts for college from family and friends. 
  • Ensure the child has skin in the game – Students can put a portion of their income from part-time and summer jobs into their 529 plan.
  • Be realistic about financial fit. If you haven’t saved enough, your child might need to attend a less expensive college, such as an in-state public college. Public colleges provide an excellent quality education, often at a quarter to a third of the cost of a private college.

At Savingforcollege.com, we aim to help you make intelligent decisions about saving and paying for education. Some of the products featured in this article are from our partners, but this doesn’t influence our evaluations. Our opinions are our own.

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