TIPS and Inflation-Protected Investments for Your 529 Plan

October 15, 2020

Many 529 plans offer Treasury Inflation-Protected Securities (TIPS) or other inflation-protected investment options. By guaranteeing a return above the general inflation rate, TIPS provide at least some measure of protection against rising tuition costs. Such protection is the primary goal of many college savers. TIPS are a good option for the low-risk portion of a 529 plan investment.

What Is a TIPS?

A TIPS is a U.S. Treasury note with a set maturity date that pays a fixed rate of interest. But it differs from other Treasury notes in that the principal of the note adjusts every six months based on increases (and decreases) in the Consumer Price Index (CPI). Not only does the principal value of the TIPS keep pace with general inflation, but the semi-annual interest payments also increase over time as the note’s fixed rate is applied to the adjusted principal.

You can buy TIPS on your own either directly from the U.S. Treasury or through a broker. Many of the larger fund families offer TIPS mutual funds.

Tax Treatment of TIPS

The interest earnings on TIPS held in your own portfolio are exempt from state taxes but are taxable on your federal income tax return. Many individuals decide to stay away from TIPS because, unlike the tax-deferred interest on U.S. savings bonds, all TIPS earnings (even the inflation adjustments) must be reported each year.

A 529 plan solves the tax problem, because the earnings in a 529 plan are not only tax-deferred, but are tax-exempt when distributed in the year the beneficiary incurs qualified higher education expenses. This makes a 529 plan an ideal vehicle for owning these investments, assuming of course that the account is ultimately used to pay for college.

TIPS Might Not Keep Pace with Tuition Inflation

Because tuition has a history of increasing faster than the CPI, TIPS may not keep up with college costs. They will do so only if the fixed rate of interest (as adjusted by any premium or discount on the purchase) is at least equivalent to the difference between college cost inflation and the consumer inflation rate.

For example, the 10-year TIPS due January 15, 2017 pays interest of 2.375% and currently trades at about 101.2% of face value, to yield 2.18%. If you purchased that note today, and did not have to pay any income tax on the earnings, your investment would keep pace with any college where college costs increase at a rate no more than 2.18 percentage points above the CPI.

Data from the College Board’s Trends in College Pricing suggests that TIPS may do slightly better in protecting against private college tuition increases than public college tuition inflation. The average annual increase in tuition and mandatory fees at private colleges over the past decade has been 1.9 percentage points above the CPI, while at public colleges the average increase has been 2.2 percentage points above the CPI. But, TIPS will fall short of both because the interest rates are very low.

Before committing your 529 dollars to TIPS or another inflation-protected option, you should be aware that, like other bonds, TIPS will fluctuate in value based on the movement of interest rates and inflation. However, if you hold a TIPS to maturity, you will be paid the greater of the adjusted principal and the original principal.

529 Plans Offering Inflation-Protected Investment Options

Listed below are all the 529 plans that offer at least one TIPS or other inflation-protected investment option. In addition to these programs there are a number of 529 plans utilizing TIPS as a component of their fixed-income options.

Alabama: CollegeCounts 529 Fund
Alabama: CollegeCounts 529 Fund Advisor Plan
Arkansas: iShares 529 Plan
Connecticut: Connecticut Higher Education Trust (CHET) — Advisor Plan
Illinois: Bright Directions Advisor-Guided 529 College Savings Program
Illinois: Bright Start Direct-Sold College Savings Program
Indiana: CollegeChoice 529 Direct Savings Plan
Indiana: CollegeChoice Advisor 529 Savings Plan
Iowa: IAdvisor 529 Plan
Kansas: Learning Quest Advisor
Maine: NextGen 529 — Client Select Series
Maryland: Maryland 529 — Maryland Senator Edward J. Kasemeyer College Investment Plan
Michigan: MI 529 Advisor Plan
Missouri: MOST – Missouri’s 529 Education Plan
Nebraska: Nebraska Education Savings Trust – Direct College Savings Plan
Nebraska: Nebraska Education Savings Trust — Advisor College Savings Plan
Nebraska: TD Ameritrade 529 College Savings Plan
Nevada: SSGA Upromise 529 Plan
Nevada: Vanguard 529 College Savings Plan
New Hampshire: Fidelity Advisor 529 Plan
New York: New York’s 529 Advisor-Guided College Savings Plan
New York: New York’s 529 College Savings Program — Direct Plan
Ohio: BlackRock CollegeAdvantage Advisor 529 Savings Plan
Ohio: Ohio’s 529 Plan, CollegeAdvantage
Oregon: Oregon College Savings Plan
Pennsylvania: Pennsylvania 529 Investment Plan
Rhode Island: CollegeBound 529 (Advisor-sold)
Rhode Island: CollegeBound Saver (Direct-sold)
South Carolina: Future Scholar 529 College Savings Plan (Advisor-sold)
South Carolina: Future Scholar 529 College Savings Plan (Direct-sold)
South Dakota: CollegeAccess 529 (Direct-sold)
South Dakota: CollegeAccess 529 (Advisor-sold)
Tennessee: TNStars College Savings 529 Program
Texas: Lonestar 529 Plan
Texas: Texas College Savings Plan
Virginia: CollegeAmerica
Virginia: Invest529
West Virginia: The Hartford SMART529