Waiting to open 529 plan can be very costly for your child's college fund

Many families wait too long to open 529 college-savings accounts, which means they miss out on the maximum benefits from the accounts, a new analysis found.

On average, 529 accounts are opened for children who are just older than 7, the investment research company Morningstar found in its annual analysis of the state-sponsored plans.

That leaves only about a decade for families to save and for the earnings to compound, said Madeline Hume, lead research analyst for 529s at Morningstar.

Money in the accounts, which take their name from a section of the federal tax code, grows tax-free and is tax-free when withdrawn and spent on eligible expenses like tuition, fees, housing, meal plans, books and equipment.

The most popular investment options for 529 plans automatically shift funds from stocks to bonds as the child ages. Most of these age-based plans created their investment tracks assuming that college savers would invest for 18 years, from birth until college, Hume said.

Early on, age-based portfolios invest in a higher proportion of stocks, which are more volatile but have more potential for long-term gains. Savers who wait until the child is 7 to open an account miss out on potential gains from early, more aggressive investments. Each year that they wait lowers the growth potential of their savings as the portfolios shift to less risky investment mixes.

Starting just one year earlier can make a significant difference, according to a model that Morningstar based on average allocations for stocks and bonds in age-based portfolios. Assuming a $50,000 investment, divided into equal monthly installments, someone who began saving when the child was 7 could expect a median balance of almost $81,000 by the time the child turned 18. With a start at age 6, the median balance would be almost $4,000 higher.

So why don't more people open the accounts sooner? Part of the reason may be that people are simply unfamiliar with 529 plans, Hume said. Another factor, Hume said, may be confusion about how a 529 account affects a student's chance of receiving need-based financial aid.

The effect depends on who owns the account. Student aid experts said the effect is generally minimal when a parent owns the account for the benefit of a dependent student. The effect can be significant, however, if a grandparent owns the account — but there are several workarounds, said Mark Kantrowitz, publisher of Savingforcollege.com.

Parents who wait until their child is 7 to start saving, he said, will have to save much more out of their own pocket to reach their goal.

"Your greatest asset as a parent is time," Kantrowitz said.

As with any investment, gains are not guaranteed. But by starting early, investors have more time to ride out the inevitable market swings.

Some age-based portfolios have more aggressive tracks than others, however, so savers should make sure to check their plan's details to be sure they are comfortable with the mix of investments as their child approaches college. If you can't stomach the idea of losing money, many 529s offer lower-risk — and lower-return — options, including savings accounts insured by the Federal Deposit Insurance Corporation and certificates of deposit.