Saving money in a 529 plan offers families a way to put cash away for college and save on taxes as well. But if your child is entering high school soon, it’s time to double-check the allocation of your investments.
Funds in state-sponsored 529 accounts, typically invested in mutual funds, grow tax-free. When you take the money out, funds aren’t taxed as long as the money is spent on eligible education costs, including tuition, room and board and books. Total investment in 529 plans reached $253 billion in 2015, according to the College Savings Plans Network.
Investments in 529 plans generally have a shorter window of time to grow than money in a retirement account does. And once a child enters high school, college is just four years away. A steep drop in the market could leave you short of funds when your child heads to campus — so scaling back high-risk investments is often a good idea, unless you have other funds available to pay for college.
“If all your college money is in the 529,” said Kim Lankford, an editor at Kiplinger who writes about the plans, “you should be more conservative.”
To help avoid that situation, most 529 plans offer age- and risk-based investment options, designed to automatically shift funds to more conservative investments as the child grows. Plans typically begin with a majority of funds in stocks, then shrink the allocation over time and add more bonds.
Still, some advisers suggest that families — even those using age-based portfolios — double-check the specifics of their 529 holdings as college nears. The mix of investments and the shift in allocation, sometimes called a glide path, vary greatly by plan.
“I’d want to look under the hood and make sure it makes sense for my particular circumstances,” said Scott Clemons, chief investment strategist with Brown Brothers Harriman.
P.J. Wallin, a financial planner at Atlas Financial in Richmond, Virginia, said that while age-based portfolios shift more money into bonds over time, fixed income doesn’t always equal “safe.”
For instance, Wallin said, the 2021 age-based portfolio in Virginia’s 529 inVest plan now has 70 percent in fixed-income investments. But with about 36 percent in “stable market” bonds, the mix also includes 5 percent in high-yield bonds and 10 percent in emerging market bonds, he said, which may be riskier than some investors want with college four years away.
Wallin generally advises clients to move half of their holdings into a money-market fund within the 529 plan when the child enters high school, and even as early as the eighth grade. “I like to put it in cash,” he said.
The point of a 529 plan, he noted, is that growth is tax-free — but it’s risky to seek a lot more growth during the high school years. “The last thing we want is to stretch for an extra $5,000 of appreciation,” he said, but lose 20 percent in a market downturn.
Christopher Parr, a financial planner in Columbia, Maryland, recalled that his daughter’s 529 fund lost a year of savings when the market dropped in 2008. “You better understand what’s under there,” he said.
Steve Stanganelli, a financial planner in Amesbury, Massachusetts, suggests that families consider moving funds for at least the coming year’s college costs into cash. Connecticut’s 529 plan, he said, generally offers a high-yield money-market option. And Lankford notes that some 529 plans even offer savings accounts insured by the Federal Deposit Insurance Corp. as an option.
By moving to safety, families may miss out on market gains. Barry Korb, a financial adviser in Potomac, Maryland, said a couple came to see him a year ago, having saved the equivalent of four years of tuition at a private college in a 529 plan. The child was starting school in six months — and 90 percent of the money was in equities.
On Korb’s advice, they agreed to shift most of the funds to short-term fixed investments. Even though in retrospect the couple would have been fine if they had left the money in stock over the past year, Korb is firm that money needed within five years shouldn’t be in the market. “I do not regret my advice,” he said.
Here are some questions and answers about 529 savings plans:
Q: Can I deduct contributions to a 529 plan?
A: Contributions are not deductible on your federal tax return. But many states offer a deduction on your state tax return.
Q: How many times can I change my 529 investment allocations?
A: You can change them twice a year.
Q: What if my child doesn’t go to college?
A: The College Savings Plans Network says that you can change the plan’s beneficiary to another family member, and they can use the funds for college. If you withdraw the money for noneducational purposes, the earnings — but not your contributions — will be subject to income tax, plus a 10 percent federal penalty. Some plans may charge extra fees or penalties.