Make investing in a 529 a new tradition

Originally published January 27, 2023 on Argus Leader; edited from the original.

The new year presents both conclusions and new beginnings. It's an important time for us all — but for financial advisors and investors, it’s a crucial opportunity for strategic retrospection and improvement.

Early in the new year, many advisors encourage their clients to review their investments and set their financial goals for the coming year. It's a perfect time to ask — what are your investment priorities? What are your financial concerns, and how can we address them?

These questions are particularly important for parents with young children, who may have yet to consider how supporting their child's future educational needs fits into their current financial portfolio.

With expenses on the rise, saving for college has become increasingly important; after all, a robust college fund can save students and their families from taking out hefty loans or otherwise putting themselves into financial jeopardy. Last year, a survey conducted by Student Loan Hero found that over two-thirds (68%) of parents "would consider withdrawing from their retirement savings to help pay for their child's education."

It's also worth noting that certain financial vehicles — namely, 529 plans — may provide significant tax and savings growth benefits to forward-thinking families. 529 plans are specifically designed to help families and individuals save money for education in a tax-advantaged way and leverage funds managed by some of the country's largest and most respected investment management firms. The plans are open to anyone with a valid Social Security number or other valid U.S. tax identification number; typically, parents or grandparents open the accounts and designate their child or grandchild as a beneficiary.

Families enrolling in a 529 plan early, could benefit from years of potential tax-deferred growth. But according to recent research, nearly three-quarters of parents who are actively saving for their child's education aren't enrolled in a 529 plan.

529 plans offer invaluable opportunities for savings growth

When it comes to building a robust college fund, the tax and savings benefits of a 529 plan are undeniable. Unlike traditional savings, 529 plan investments grow tax free and, if used for a qualified educational expense (e.g., college tuition, private primary or secondary school, books, etc.), won't be taxed at all upon withdrawal.

These accounts also enjoy favorable treatment during aid eligibility assessments because reviewers classify a 529 as a parental asset rather than student funds. Per the federal financial aid formula, roughly 20% of student assets are expected to be allocated toward college expenses. However, parents are expected to contribute just 6% to the cause — which means that a student whose college fund is stored in a 529 could potentially receive more aid based on this calculation than a peer who keeps their education dollars in a traditional savings account in that student’s name.

Notably, this ownership arrangement also provides value to the parent or account holder who retains complete control over the account, even after their child reaches adulthood. They can decide how to invest their contributions, when to make withdrawals, and how those withdrawals will be dispensed. Account holders can even reclaim the funds if they choose; however, distributions that aren't used for qualified educational expenses may be subject to income tax and a 10% federal penalty.

In most cases, it's better to use the funds as they were intended: for education. Fortunately, beneficiary status is transferable; if a child decides not to pursue further education or doesn't use all of the money in a 529 plan, the account holder can designate a sibling or other eligible learner as the new beneficiary.

Fund allocations are strategic and flexible

For investors and financial advisors, understanding how an investment plan allocates its assets is fundamental to developing a robust college savings strategy. After all, different assets correlate with varying degrees of risk; an account consisting mainly of stocks, for example, will tend to be higher risk than one consisting mainly of bonds. Heather Bergman, managing director and senior portfolio manager with the Virtus Multi-Asset Team, explained how the process works in the CollegeAccess 529 plan. “Along with stand-alone fund choices, we offer age-based portfolios that automatically reallocate assets from predominantly equities to a progressively heavier weighting toward bonds and cash-like instruments as the child approaches college age. The goal is to position the account for income and capital preservation by the time the child enters college."

Bergman and her colleagues at CollegeAccess 529 take this mission seriously. Every year, the team's portfolio managers discuss the expected economic backdrop for the coming year, consider how different asset classes may potentially perform in that environment, and ultimately make decisions about how best to allocate assets.

"For example, in a year where the Federal Reserve is expected to tighten monetary policy and raise interest rates aggressively, we would look to reduce our exposure to certain bonds within each of our age-based investment portfolios— that's what we did last year," Bergman said.

These carefully considered allocations can be invaluable for families who plan to take a long-term and relatively hands-off approach to fund growth. However, account holders aren't limited to age-based portfolios. Investors can also opt into static portfolios that leverage stock, bond, and ultra-short-term bond options to create an account aligned with their risk tolerance. In addition, financial advisors can help clients construct a suite of investments based on available mutual funds in the program in order to define their own allocation. In these cases, it’s also possible to supplement an age-based or static option with additional exposure to a given asset class, if they choose.

"The choice you make depends on the situation at hand," Bergman said. "If you're opening an account when the child is young, it's probably best to go with an age-based portfolio. But if you open the account during the child's high school career and you're willing to take on more risk to potentially grow your savings quickly, working with a financial advisor and applying a custom strategy might be a better tactic."

Contribute what you can, whenever you can

Every contribution, no matter how small, can positively influence a student's ability to pursue their academic dreams.

"It's important to do what you can," Bergman said. "Starting to save early is critical."