Rethinking the 529 College Savings Plan Strategy
For years we've been plowing money into 529 plans for our children (after, of course, contributing to our retirement accounts as well), knowing how painful it's going to be 10-15 years out when we start getting those tuition bills. Generally, I've always been a strong proponent of relying heavily on stock market returns over long periods of time since they tend to outperform all other asset classes in periods of 10 years or longer (with 2000-2010 being a notable exception). As such, we have our 529 plan portfolios set up to invest in the most aggressive stock portfolios I could find, with the intention of shifting gears into more conservative stock/bond mix portfolios as the kids reach their teenage years in order to protect the principal in the event of a downturn like what we saw in 2008 and 2009. However, I'm starting to rethink this approach.
529 Investing — Buying Tuition Credits or Investing in Stocks
The reason I'm rethinking my strategy has little to do with the market downturn in 2008 and 2009. I'm not easily influenced by "the recency effect," and I don't change long-term strategies unless there's a game-changing definitive driver. Rather, the input that's making me rethink our strategy is the trajectory of college tuition costs and the prospect that there's no relief in sight. (See also: Beyond Tuition: Helping Out With College Expenses)
The most recent survey of college tuition costs from The College Board indicates that for the 2010-2011 school year, in-state tuition and fees will rise 7.9%, a staggering number. Private schools will see their costs increase 4.5%, but being mindful that private schools are generally 3-5 times more expensive than a top state school (and hence prohibitively expensive for us to fund fully), it's the state-school tuition hike that we're paying close attention to. Debt-burdened state budgets are facing an uphill battle, confronted with interest payments coming due mixed with declining tax revenues from a stagnant economy. I'd like to be more optimistic, but the pragmatist in me views this as a longer-term issue with the net result being continued lack of funding for public universities. As a result, it won't suprise me if we continue to see hikes of 7-9% for years to come.
Changing Strategy — What if I Guess Wrong?
By having prepared, and either saving a hefty amount in the 529 plan in a stock/bond mix or having purchased several tuition credits in advance, at least we will have taken a step in the right direction, no matter which option turns out to be the better investment. However, if it turns out that stocks average 2% or 12% over the next 15 years, buying tuition credits in advance will have either looked like a genius move or an overly conservative lost opportunity. In order to have it both ways, I'm actually going to look to start a new 529 plan to purchase tuition credits while retaining the aggressive market-based portfolio in my other plan. This way, I've mitigated my risk substantially. As far as weighting, I think I may start funneling money more heavily toward the credit option because the chances of college tuition costs dropping dramatically over time seem slim, as does the prospect of stocks having "above average" market performance, given that we're coming off a massive 75% gain from the pivot bottom in March 2009, and we're likely looking at very low single-digit GDP growth for years.
Multiple 529 Plans Are Allowed
Since most 529 plans don't have state residency requirements, you can usually have accounts with multiple state plans. Since I started with the Ohio savings plan due to their portfolio selection and low fees, I can actually do a state tuition credit plan in my home state. So, legally and practically speaking, my plan is achievable.
By buying credits each year that are expected to increase at 8% or more, that's essentially my "investment return." What makes, say, an 8% return on college tuition credits so much more attractive than an 8% return in stocks is the lack of volatility. While stocks will continue to see-saw up and down with no guarantee of beating 8%, college tuition increases over the years. Thus buying tuition credits is the equivalent of earning a very high "risk-free return," which is presently in the very low single-digits for savings, CDs, and Treasury bonds. The intangible risk we're already taking on is that we'll save too much if one or more of our children doesn't go to college. Fortunately, there's ample flexibility built into 529 plans to redistribute savings to other family members or withdraw the money with a penalty as a last resort.
What's your approach to 529 plan savings?
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