Get Smarter With College Savings Plans
If you are saving for college in a 529 plan, you probably took a bigger hit than you expected during the 2008 market crash.
What should you do now? Keep the plan or dump it?
My opinion: Stay in the 529 world but in a smarter way. These plans, run by the states, can be a great, tax-saving way to put aside money for college. You invest with after-tax dollars, but the earnings are tax-free if they are used to pay for higher education.
Thirty-four states and the District encourage contributions by giving you credits or deductions on your state tax return. You can buy a 529 from the state, at a low cost. Or buy at a high cost from stockbrokers and financial planners.
Smart idea No. 1: Buy through the state. When you open a 529, you have a wide variety of investment choices. The most popular are the age-based plans. They buy stocks while a child is young and promise to grow more conservative in the years just before college entry. Good age-based funds keep their promise. You have plenty of cash on hand when the tuition comes due.
Irresponsible age-based funds gamble on earning higher returns. They continue to hold a large proportion of stocks and risky bonds, even for 19- and 20-year-olds. These are the funds that get parents into trouble. If you are paying tuition this year, 20 percent or more of your college money might be gone.
One 529 expert, Joseph Hurley of Pittsford, N.Y., recently surveyed the performance of 529 portfolios designed for children on the cusp of college age (17 and older). Every one of the pricey plans sold by brokers and financial planners showed losses of more than 10 percent for this age group in 2008.
The record is better -- although far from perfect -- for the 529 plans sold by the states. Twenty-two percent of them suffered more than 10 percent losses and 12 percent showed gains. For the full tally, see Hurley's Web site at http:/
In the two years right before college, a good age-based 529 plan should be invested largely in shorter-term bond funds, money-market funds and insured certificates of deposit. The direct-sold plans that do this right include the "moderate" or "conservative" portfolios in Arkansas, Colorado, Idaho, New York, Nevada and North Dakota, Hurley says. They are administered by UPromise or Vanguard Group, both known for their low-cost approach.
At the other extreme, West Virginia's direct-sold Smart529, administered by Hartford Life Insurance, kept its 17- and 18-year-olds 45 percent in stocks last year. North Carolina's CollegeHorizonFunds, managed by J.W. Seligman & Co., stayed 38 percent in stock. Rhode Island's CollegeBoundfund, run by AllianceBernstein Investments, chose 35 percent for stock. They all got slaughtered when the market dropped.
Why did the states go along with such imprudent investment allocations?
Nelson Sorah, communications director for West Virginia, says the plan has to keep up with college inflation, which requires a high commitment to growth. That's a dandy theory for long holding periods, even if it doesn't always work. But no sensible adviser would say that it's safe to gamble on a rising market over any one- to two-year timeframes.