Automatic investing in a 529 plan is a proven strategy to help families save more for college. If a family has to remember to make a 529 plan contribution each month, they are likely to forget and miss out on potential tax-free earnings growth. By making college savings automatic, investors will benefit from dollar-cost averaging and minimize volatility in their 529 plan.
What is automatic investing?
Automatic investing allows individuals to schedule automatic transfers from a bank account to a linked 529 plan, IRA or other investment account. Deposits are scheduled to be made on a regular basis, typically once a month.
Automatic investment plans take the emotion out of investing by continuing to make contributions regardless of financial news or short-term market volatility. This “set it and forget it” method helps families stay on track to meet their college savings goals, since they can move money into their 529 plan without having an opportunity to spend it on something else first.
How to set up automatic investments in a 529 plan
Parents may set up automatic investments when they enroll in a 529 plan. Many 529 plans offer a lower minimum initial contribution amount when an automatic investment plan is set up.
For example, Wisconsin’s Edvest 529 Plan requires at least $25 per investment for lump sum contributions, but the required minimum contribution is reduced to $15 per investment when the automatic investment plan is used.
Families may start, change or stop an automatic investment plan for an existing 529 plan account. Unlike 529 plan investment changes, which are limited to twice per calendar year, parents may change their scheduled contributions at any time.
Automatic payroll deduction
Some employers offer an automatic payroll deduction option for 529 plans. With automatic payroll deduction, 529 plan contributions are made with after-tax dollars taken directly from the 529 plan account owner’s paycheck.
Automatic payroll deductions are set up by completing a form on the 529 plan’s website and submitting a copy to the 529 plan account owner’s employer. The same form is typically used to start, change or stop automatic payroll deductions.
Similar to retirement saving benefits, companies may also offer an employer-sponsored 529 plan and matching 529 plan contributions as part of their employee benefits program.
Benefits of automatic investing
In most cases, 529 plan investors are able to save more for college with an automatic investment plan than if they chose to make manual contributions. Families who intend to manually contribute to a 529 plan each month are likely to forget and skip their contributions occasionally. However, skipping even one 529 plan contribution per year can make a big difference in the ending balance when it’s time to pay for college.
For example, a family with a new baby must contribute $250 each month to a 529 plan over the next 17 years to reach their college savings goal of $88,000, assuming a 6% annual investment return. The ending balance consists of $51,000 in contributions and around $37,000 in earnings.
If the family decides to make manual contributions and skips every 12th month, the total contributions and ending balance are reduced by around 1/12, yielding $46,750 and $81,550, respectively.
If the family skips every 4th contribution (three a year), the total contributions and ending balance are reduced by around one quarter, yielding $38,250 and $66,728, respectively.
As shown in the table below, this hit or miss approach reduces a family’s total savings proportionately, by the amount of skipped contributions, with a corresponding reduction in earnings. The family can always catch up on skipped contributions, but they will miss out on interest earned from tax-free compounding.
Number of Monthly Contributions Skipped
Total 529 Plan Contributions
Total Ending 529 Plan Balance in 18 Years
Skip every 4th month
Skip every 8th month
Skip every 12th month
Automatic investing allows families to take advantage of dollar-cost averaging in their 529 plan. Dollar-cost averaging works by purchasing fewer shares when markets are up and prices are higher, and purchasing more shares when prices are lower.
If a family panics and cashes out their 529 plan investments when markets are down, they lock in their losses and risk missing out on a potential recovery. But, if the family sticks with an automatic investment plan and consistently makes regular contributions over an 18-year period, the average cost per share will represent both the premium prices of a bull market and the discounted prices of a bear market.A down market presents an opportunity to buy more shares at a lower cost per share.