529 College Savings: The Cost Of Waiting

In previous posts, we’ve covered how today’s parents are starting college funds for their children earlier than previous generations.

According to a Vanguard study on its 529 plan account holders, “0” is the most common age when 529 accounts are initially funded. The median age when 529 accounts are initially funded is 3.5 years. Both data points show that many families are starting their child’s college fund well before Kindergarten.

Starting earlier has multiple benefits. When 529 contributions are consistent, starting early can increase the number of viable options for education.

For many families that do not save for college, maybe due to the fear of losing out on financial aid, the financial gap between the family’s savings and the cost of attending an institution can prevent students from enrolling in top-tier universities that they were otherwise accepted to.

Starting your child’s college fund early can prevent them from having to turn down schools they are accepted to

Starting the 529 plan early also reduces the student’s debt burden post-graduation, which can increase their ability to pursue different careers, make major long-term family and financial decisions (e.g., getting married, buying a house, having a child), and pursue entrepreneurial paths.

Student debt struggles in their own pasts are probably the main reason why parents are starting their college funds earlier than previous generations.

Starting early is important, but just how important?

To answer this question, SavvyFi ran the numbers to show a hypothetical “cost of waiting” and the importance of funding a 529 college savings plan as soon as possible.

To perform this study, we considered an age-based fund with an 18-year annualized return of a little under 6%. Age-based funds start out allocated toward higher-growth equities when the beneficiary is young and switch to more conservative investments, such as bonds, as the child nears graduation from high school.

Therefore, the returns for earlier contributions have more years to grow and initially grow at a higher rate.

Comparing Two Families

We compared two hypothetical families that both contributed $200 a month to their child’s college fund.

The first family, who we’ll call the Onnit Ozwald’s, started the 529 fund right when their child was born. The second family, the Waiting Wilson’s, started their 529 fund when their child turned six.

The returns, investments, and contributions are otherwise the same for both.

After eighteen years of contributions for the Ozwald’s, and twelve years of contributions for the Wilson’s, the Ozwald’s will have saved over $33,000 more than their procrastinating counterparts.

The graphic below shows that over half of that extra $33,000 was free money from earnings!

Starting the college fund at birth rather than at age 6 could yield over $30,000 in extra savings

You’ve probably heard that years of compounding investment growth is one of the best tools that savers have in their arsenal. That is particularly true in the case of college savings, where the maximum time to accumulate investment growth is usually capped at around 18 years.

Digging into the numbers a bit more, we can see that for the Ozwald’s, earnings make up about $4 out of every $10 in total savings. For the Wilson’s, only $3 out of every $10 in total savings was from earnings.

So, not only did the Waiting Wilson’s save over $30,000 less than their counterparts, they also gained 25% less “free money” from investment earnings.

Looking at the proportion of total savings for a family that starts their child’s college fund at “age 0” reveals some interesting insights.

If a family simply saved in a 0%-interest checking account, we would expect the proportion of savings from ages 0-5, 6-11, and 12-17 to be equal thirds. So, if they saved in $60,000 total, $20,000 would have been contributed during each of the three time frames.

However, when we include hypothetical earnings from investment growth, we see that 45% of the “total savings” (i.e., contributions and investment growth) results from contributions made during the first third of the child’s life.

Almost half of a child’s total college savings could result from contributions made during the first third of the child’s life

Due to budget and time constraints, starting the college fund earlier can be a tall order for busy families.

If you have a little one on the way, you can get a leg up by starting the college fund before your child is born. In addition, using gifting tools can be a great way to capitalize on the important early growth years even if you are not able to consistently contribute to the college fund.

However, if you can be like the Onnit Ozwalds and make consistent monthly contributions early on, it can make a big impact on which institutions your child can attend and how much student debt they will leave school with.

Ending Note: SavvyFi is an investment adviser registered with the Securities and Exchange Commission. They like for us to reiterate that all of the examples in this article are hypothetical, involve assumptions that may or may not prove true, and should not be interpreted to mean investments cannot lose money. See the footer on this website for more information.

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