Does a 529 Plan Make Sense with Less than 10 Years to College?

529 Plan One way families can help save for college is through a 529 Savings Plan but does a 529 Plan make sense with less than 10 years to college?

Recently, I received a press request asking for comment on ways families can save or lower the cost of college. With less than ten years away from entering college, what can a family do? It was suggested that at ten years out or less it was past the stage of opening a 529 Plan.

Thumbs Up for 529 Plans

So when I was asked whether or not a 529 Plan makes sense with less than 10 years until college, I gave an unequivocal ‘thumbs up’.

Just because a family has a student who is 10 years away from college doesn’t necessarily mean that a 529 is not a good option. In fact, a 529 Plan can even make sense if a student is entering college next year.

While it’s true that a family has less time for the funds to compound and deal with possible market corrections, that doesn’t mean that a 529 Plan doesn’t have a role even in what I call ‘late-stage’ college planning.

529 Plans Compared to Alternatives

Yes, you have access to a host of alternatives: saving in a brokerage account, CD or money market for instance. Perhaps you may buy US Savings Bonds.

Aside from the Savings Bonds, all the other options mentioned could result in taxable gains or interest.  With a 529 plan, the parent doesn’t have to worry about paying such a tax when proceeds are used for qualified education expenses.

Many 529 plans offer money markets and some yield way more than anything available outside in the marketplace.  The Connecticut plan (CHET) has a very high yielding (relative to everything else) money market to hold cash.  Why would I tell a parent to tie the money up in a taxable account (even if just a CD or money market) which would lead to a potential tax bill that eats away at the savings? Through the money market option in these 529 Plans, a family can park savings in a relatively low-risk investment and not have to get hit with taxes.

I advise parents of college-bound students all the time (college financial planning is my niche) and even with a high school senior I’ll advise using a 529 plan.  And why not?  If the parents were using savings or investments, they can move the funds into a 529 and take advantage of any number of conservative investment allocations (including the money market) and save on taxes. Unlike a CD which pay miserly rates of interest and come with a penalty if you tap the account to pay your college bill prior to the CD’s maturity, you have full penalty- and tax-free liquidity with a 529.

529 Plans Reduce Tax Bite

This strategy is especially important for the parents with non-529 savings (taxable accounts) allocated for college that have built-in capital gains.  In some cases, gifting such assets to the child who will be (most times) in a lower tax bracket compared to mom and dad can reduce the tax bill (i.e. kid may be in 0% to 10% income tax bracket so low to no capital gains recognized on his return).  And then the proceeds can be shifted to a 529.

Since financial aid formulas effective Fall 2016 now use the taxes from the student’s ‘prior-prior year’ it is all the more important to plan these moves at or prior to high school sophomore year.

With ten years until college, the funds will still need to try to keep pace with college inflation.  When college costs increase 4% year-over-year (at least) for private schools, then a CD or savings account will do little to keep pace (even with the likely increase in market interest rates coming later this year).

Use Family and Friends to Fund College

I prefer the strategy of having parents save the funds by investing in a 529 Plan that is owned by another family member.  Such assets are not countable for purposes of calculating FAFSA or Profile EFC.  This may be important to you if your student may qualify for needs-based aid. Then you can have the family member disburse funds after the last financial aid forms are signed and the student is in his second semester junior year or beginning his senior year in college. Doing this the student is not penalized as this is not counted as a resource.

Use Roth IRAs as College Funding Alternative

Another tactic I advise is to fund a Roth IRA for the student.  This works if the student has W2 income including working for a family business.  Retirement accounts are not part of the EFC calculation.  But with at least five years of ‘seasoning’ the funds can be taken out by the student for a qualified education purpose without penalty.  And as part of a Roth IRA, the funds accrue without paying taxes along the way allowing for more tax-deferred build-up (almost like a 529) but with more access to more investment options.

And in this case I would focus on index funds.  I like Vanguard Wellington (VWELX) (if you can find a platform that will still allow purchases like Folio Institutional) and index funds.

Plan Now, Pay Less Later

So, does a 529 Plan make sense for a student with less than 10 years – or even one year – until college? It sure does.  And because every situation is different you need to coordinate your savings with a broader college funding plan. If you are curious about your options or confused about how to balance saving for college with other equally important goals like retirement, then reach out to our college financial planning team and arrange for a complimentary initial consultation.