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Using 529s for your "safe" money
You see the ads all over the place: Open up a new bank savings account or certificate of deposit and you can start earning interest of over 3%, maybe even as high as 4%. Parents with children approaching college age may be tempted to park their college savings in one of these high-yielding accounts and avoid the short-term market risk that comes with stocks and longer-term bonds.
However, before you run down to your local bank branch, consider income taxes. If we assume you are in a 30% combined federal/state income tax bracket, your after-tax return on a bank CD earning 3.5% shrinks to 2.45%.
You may be able to do significantly better than 2.45% on an after-tax basis in a 529 plan and still avoid market risks. That's because (1) we are seeing more 529 plans with bank products and other principal-protected investment options, and (2) your 529 earnings are 100% federal tax-free.
Here are just a few of the "safe" options you can find in 529 savings plans:
- Ohio's CollegeAdvantage 529 plan offers FDIC-insured savings accounts earning 1.5 - 1.75% APY (May 15, 2008) with no minimum balance, and certificates of deposits ranging from three months to twelve years with APY of 2.50% to 4.00% with a $500 minimum.
- CollegeSure® CDs through College Savings Bank are offered through Arizona's and Montana's 529 plans. These are also FDIC-insured and are available in maturities from one to 22 years. Your earnings will be pegged to a national index of private-college tuition increases, less a 3% margin, with a 2.0% floor. While you can be certain your investment will not keep up with tuition inflation—you give up that hope with just about any safe option—consider that 2007's tuition index posted a 6.02% increase. Under the CD's current terms, that would have translated to a 3.02% crediting rate.
- TIAA-CREF makes a "Guaranteed Option" available in the 529 plans it manages. For example, the Guaranteed Option in Minnesota's 529 plan is yielding 3.25% through March 31, 2009 and will never go below 3%. There is also no minimum holding period so you can put the money in today and take it out again in a month.
- "Stable-value" investments are similar to a guaranteed option and are available in many other 529 plans. Money-market options are also prevalent. Be sure you understand the fee structure of any of these investment products as fees can have a significant impact on your returns.
We provide these examples merely to illustrate the opportunities for putting your safe money into a 529 plan. They are not investment recommendations. Many prepaid tuition plans also provide protection from market risks. To have any chance of keeping up with college inflation, you may have to allocate at least a portion of your savings to higher-risk investment options.
Posted May 24, 2008