Like any parent with pre-college age children, you've likely been exposed to repeated messages about the importance of setting money aside to help your kids afford higher education. This is not surprising when you consider the 2020-2021 average annual cost for tuition, fees, room and board at a four-year private college was $54,880. 

Paying for higher education is a prominent financial issue for many families, which is why starting early and saving regularly can help give you additional leverage to grow assets and offset some of the financial burden. And utilizing a tax-advantaged 529 savings plan - even if that means starting one just a few years before your kids graduate from high school - may be an effective tool to build a college nest egg.

529 plan basics

529 plans allow you to set funds aside for the express purpose of helping to cover education costs. Contributors can choose from a variety of plans and invest the money in different ways, giving 529s a broad appeal. Some key benefits of 529 plans include:

  • High lifetime contribution limits — from $235,000 to $520,000, depending on your state.
  • Tax-deferred earnings, and tax-free access to all distributions used for qualifying education expenses.
  • Oversight of the account that remains with the donor, not the beneficiaries.
  • Flexibility to change the beneficiary (for example, in case the intended beneficiary decides not to go to college).
  • The ability to utilize a five-year gift election, where plan contributors can make the equivalent of five-years' worth of gifts in one lump sum while potentially mitigating gift tax consequences.

Can you overcome a late start?

If your child (or children) is approaching college age, you may wonder if it is too late to start contributing to a 529 plan.

“Just because you haven't started saving in a 529 to this point doesn't mean you should forego the valuable benefits," says Angie O'Leary, head of wealth planning at RBC Wealth Management-U.S. The earlier you set funds aside to help cover education costs of a future collegian, the greater the opportunity to build a significant pool of assets, she says.

For example, consider what happens when parents start saving right after their child is born.

  • They first invest a lump sum of $2,000 into a 529 plan, and continue with monthly $300 contributions until age 18.
  • By the time that child enters college, the account grows to $130,077 (assuming an average annual return of 6.21 percent).
  • By delaying that same savings regimen until the child's sixth birthday, the account would only grow to $73,026. If parents didn't begin saving until the child turned 12, the total value would reach just $33,284.

Tax savings still count

You may have to follow a more conservative investment path with a 529 plan if college is fast approaching for your child. Still, it's likely to be worthwhile, according to Alan Wolberg, a senior wealth planner at City National Bank. “If your kid has just started college and you haven't opened a 529, even getting two or three years of potentially tax-free growth in the account can be helpful," he says.

"Engage your village," O'Leary also recommends. "Forgoing material gifts and inviting others to contribute to the fund is a great way for extended family and friends to show the value of a higher education." This can include family members — such as grandparents, aunts and uncles of the beneficiary — who by gifting can turn those dollars into tax-advantaged contributions. Depending on what state they live in, it's possible these contributors may be able to claim a deduction on their own state tax return.

If you have a pool of money sitting in a taxable savings or investment account, it may also be used to fund a 529 plan. One option, if you hold assets that are subject to capital gains taxes when sold, is to gift those assets to a child who's likely to be in a lower tax bracket. The child can then sell the assets at a lower capital gains tax rate (possibly even qualifying for a zero percent rate) and put the proceeds into a 529 plan (as long as the child is age 18 or older).

Leveraging the flexibility of a 529 plan

“Even if you start saving late in the game," says Wolberg, “a 529 may have longer-term benefits you didn't initially anticipate." Rather than using accumulated assets to help defray education expenses for your own children, for example, the money may instead be allowed to accumulate and be applied toward college expenses far into the future. For example, says Wolberg, if a child decides to pursue a graduate degree, that can extend the potential time horizon for the funds in the 529 plan to grow.

Wolberg points out the flexibility of 529 plans may also allow you to think beyond just the immediate potential needs for college. The scope of these plans expanded with the Tax Cut and Jobs Act (enacted in 2017). Today, funds accumulated in 529 plans may also be used for elementary and high school education expenses.

“Another option is to set aside as much as you can afford now and let that money grow over a much longer timeframe," says Wolberg. “Ultimately, assets accumulated in the account could be used to help fund education costs for your grandchildren." Quite simply, according to Wolberg, don't discount the possibility that, while you may be late in saving for the current generation, you can get a head start on the next generation's education expenses.

When a 529 plan may not be enough

Even with generous contributions from yourself and others, personal savings, money accumulated in a 529 plan and annual cash flow may not cover the cost of college in a given year. The financial challenge can be even more severe for families with multiple kids in college, particularly if parents want to avoid making their child take on student loan debt.

A valuable funding source in addition to a 529 plan, says O'Leary, is for parents to utilize their own line of credit. “It is realistic for parents funding higher education for one or more children to come up short or have liquidity challenges," she says. “A line of credit may offer a more cost-effective way for families to borrow money to fill in any gaps and avoid traditional student loans."

RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.

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