Is it too late to start saving for college?


My daughter will be enrolling in college in two years. Is it too late to start saving for college? If not, which type of college savings plan is best?


With only two years left before a child starts college, most of the money in the child’s college savings plan should be invested in conservative investments, where there is little or no risk of loss to principal. No more than 20 percent of the money should be invested in stocks or other risky investments.

This means that the return on investment will be low, just a few percent. There also isn’t much time for the earnings to accumulate, so the tax-free distributions don’t yield as much of a tax benefit.

Given this, even the state 529 college savings plans with the lowest fees, which are around 0.5 percent, will yield a negligible benefit because the fees will consume a significant portion of the investment returns, more than the potential tax savings.

The main reason to make additional contributions to a 529 plan during the last two years prior to college matriculation is for the tax advantages, if the account owner lives in one of the 35 states (including the District of Columbia) that offer a state income tax deduction or tax credit on contributions to the 529 plan. This tax benefit is equivalent to a 3 percent to 10 percent discount on tuition and other qualified higher education expenses, depending on the account owner’s marginal state income tax rate.

Otherwise, it may be best to save the money in a taxable account in the parent’s name, since this will avoid the fees associated with an investment in a 529 plan. The fees during the last two years may consume a greater percentage of investment returns than capital gains tax rates for most investors. Saving the money in a taxable account also provides the parent with more flexibility to spend the funds on other expenses in the event the child does not attend college or wins a big scholarship.

The impact on financial aid is the same, regardless of whether the money is saved in a parent-owned 529 plan or in taxable accounts owned by the parent, and must be reported as a parent asset on the FAFSA (Free Application for Federal Student Aid).

The low investment returns during the last two years before the child starts college should not be seen as an excuse to not save, since every dollar saved is a dollar less borrowed. Rather, it should affect only the manner in which one saves for college, not whether one saves.