'Safe' 529 options may lag inflation

By: Savingforcollege.com

Q:

Dear Joe, If I invest in a 529 college savings plan, is my principal protected from stock market losses? -- M. Flores

A:

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.

Popular Questions

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Two kids, two 529 plans?

Dear Big Bill,While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan , check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.Learn more about Coverdell ESAs.Original post date 2013-07-15
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