By Freddy Lopez

The 529 college savings plan is widely regarded as one of the most tax friendly tools available for funding a child’s future tuition, but how one invests within those plans can make a big difference in the potential return and level of risk.

While 529 plans differ depending on the state that sponsors them, most offer a selection of funds. Investors can typically choose which type of investment strategy they wish to deploy — either static, in which they select an asset allocation which is up to them to adjust, or “age based,” in which the account automatically becomes more conservative as their child approaches their college years.

529 College Savings Plan Definition

A 529 saving plan is an investment account that enables families to save for future college costs on a tax-favored basis. While contributions are not deductible, any earnings in the account can be withdrawn tax free if used to pay for qualified education costs — including tuition, fees, books and room and board.¹

Earnings not used for qualified expenses will not only be subject to income tax, but also generally hit with an extra 10 percent penalty. (The penalty is typically waived in the case of a death or disability, or if a child receives a scholarship.)

If a child chooses not to attend college, the beneficiary can generally be changed, passing any unused money in the 529 account along to siblings – or other qualifying family members – penalty-free. That money must be used for qualified education expenses.

Most states sponsor their own 529 plans, and some offer a state income tax deduction or credit to residents who participate in their plan. Investors, however, are not restricted to their own state’s 529 – they can participate in any 529 plan they choose.

By contrast, a 529 prepaid tuition plan is not an investment. Rather, it enables individuals to purchase credits based on today’s in-state tuition costs for use by their child in the future – effectively locking in the current cost of tuition. Kids who select a private or out-of-state school generally get back the equivalent of current in-state public college tuition, and pay the difference on their own. Prepaid 529 college savings plans do not generate a return based on market performance, but they are also devoid of market risk.

The Age-Based 529 Model

For many parents, especially those who seek to generate modest returns while also managing risk, the age-based 529 investment model is an appropriate fit. The age-based strategy is a “set it and forget it” solution in which the portfolio is heavily weighted to stocks until the beneficiary (college-bound child) reaches about middle school, at which point the asset allocation gradually shifts to include a higher percentage of cash and bonds – securities that traditionally generate lower returns in exchange for lower risk. (Past performance is, of course, no guarantee of future returns.)

Because age-based plans automatically adjust over time, they also may be ideal for families who do not have the time or tools to monitor their 529 portfolio. The 529 plan age-based strategy helps to minimize the risk of having to potentially liquidate an equity-heavy portfolio in a down market when the first tuition payments come due but it may not generate the kind of returns needed to meet the rising cost of higher education.

Static 529 Plans

More experienced investors who are willing to assume greater risk in exchange for the potential to attain higher returns, may instead wish to select a static (or build-your-own) 529 investment plan. Static accounts enable investors to target a specific risk level or create an individual portfolio that tracks underlying mutual funds, exchange-traded funds or other investments. The asset allocation in such plans does not change over time unless the account holder requests it.

Static plans are also the tool of choice for the highly risk averse; those who merely wish to put money into a relatively “safe haven” bond portfolio that is designed primarily to preserve principal (or their contributions) and not generate higher returns.

Compare 529 Plans

Families who are considering opening a 529 account should be sure the investment strategy they select matches their tolerance for risk and need for returns. For some families, the best solution is to diversify. Of course, families can change their 529 plan investment options over the years. A trusted financial professional can help you find a plan that fits your needs.

Provided by Freddy Lopez, courtesy of Massachusetts Mutual Life Insurance Company (MassMutual).

1 Internal Revenue Service, “529 Plans: Questions and Answers,” 2016. The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Provided by Freddy S. Lopez], courtesy of Massachusetts Mutual Life Insurance Company (MassMutual)

This article was originally published in the 2022 New Year Issue of Las Vegas PRIDE Magazine, and can be read in its original format here.