'Safe' 529 options may lag inflation


Dear Joe,

If I invest in a 529 college savings plan, is my principal protected from stock market losses?

-- M. Flores

Dear M.,

Not necessarily. Most investment options in 529 plans can go up or down in value, just like investments in your IRA or 401(k). The state sponsoring the 529 plan does not guarantee your account against losses.

However, recognizing that a significant percentage of families do not want to risk their college savings to the stock market, nearly all 529 savings plans now offer some type of principal-protected or stable-principal option.

These options can include money market funds, certificates of deposit, guaranteed-investment contracts and stable-value investments.

Here are a few examples of the "safe" options you can find in 529 savings plans.

  • Ohio's CollegeAdvantage 529 plan offers FDIC-insured savings accounts earning 2 percent annual percentage yield, or APY, (as of April 2008) with no minimum balance, and certificates of deposits ranging from three months to 12 years with APY of 2.25 percent to 4 percent with a $500 minimum.

  • CollegeSure CDs from College Savings Bank are offered through the Arizona and Montana 529 plans. These are also FDIC-insured up to $100,000 per depositor and are available in maturities from one to 22 years. Your interest rate is pegged to a national index of private-college tuition increases (less a 3 percent margin) not to go below 2 percent. 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 percent increase. Under the CD's current terms, that would have translated to a 3.02 percent crediting rate.

  • College Savings Bank recently introduced the InvestorSure CD through the Montana 529 plan. You receive at least 85 percent of the increase in the S&P 500 Index over the term of the CD. If the value of the S&P 500 declines over the investment period, you receive your full investment back at maturity.

  • TIAA-CREF makes a principal-protected option available in the 529 plans it manages. For example, the Guaranteed Option in Minnesota's 529 plan is yielding 3.25 percent through March 31, 2009, and will never go below 3 percent. There is also no minimum holding period, so you can put the money in today and take it out again in a month.

  • In a 529 prepaid tuition plan, your investment return is not directly tied to the market. The plan promises to pay a certain level of benefits regardless of market conditions. Several states offer a prepaid tuition plan to residents, or you can consider the Independent 529 Plan run by a consortium of more than 270 private colleges.

These examples are for illustrative purposes and are not investment recommendations. Make sure you understand the fee structure of any of these investment products, as fees can have a significant impact on your returns.

Remember, you may have to allocate at least a portion of your savings to higher-risk investment options to have a better chance of keeping up with college inflation.

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