Optimizing an investment in your child’s 529 plan is more important now than ever, with college costs rising significantly higher than the rate of inflation over the past decade.
“If you are going to grow the money invested in a 529 plan faster than the tuition inflation monster is shrinking it, you need to be aggressive,” says Lawrence Solomon, client advisor at Mercer Advisors in Vienna, Virginia.
That means picking a plan with great investment options, low fees, high investment returns and decent tax benefits, says Ksenia Yudina, a Los Angeles financial advisor and head of U-Nest, a mobile app designed to help families save for college.
Easy, right? 529 earnings may grow tax-deferred, and withdrawals for qualifying expenses may be tax free, but there’s more you need to know to make sure junior gets the biggest bang for your buck in college:
— Consider a target-date fund.
— Coordinate if you have multiple children.
— Compare state plans.
— Diversify and rebalance.
Read [How Investors Can Best Use a 529 Plan.]
Consider a Target-date Fund
There’s no need to play the market with your child’s school money. Target funds are “specifically structured to take into consideration the age of the child and the time horizon,” Yudina says.
These funds are constantly optimized behind the scenes to increase allocation to safe, low-risk investments as the child becomes older and approaches college, without you having to pay much attention to it.
“It’s an effective way for parents to pick the best optimal portfolio even with limited knowledge about investments and eliminates the need for parents to manually change asset allocation over time,” Yudina says.
But keep in mind that target-date retirement funds are different from target-date 529 funds, which tend to result in no equities at the time of matriculation, says J.R. Robinson, founder of Financial Planning Hawaii.
Conversely target-date retirement funds are usually designed to be 50 percent equities at the time of retirement. And if your child is nearing matriculation now, keep an eye on the target-date funds that may be heavily weighted to bonds, which may “decline in value as interest rates rise from historic lows,” he says.
Coordinate if You Have Multiple Children
Parents with multiple children may wish to use a combination of plans. Robinson notes he has four children and three 529 plans, including the Private College 529 plan that allows parents to prepay tuition at nearly 300 private colleges. Since his oldest is attending one of the schools on the list, Robinson is using savings from Private 529 plan toward this objective and changed the beneficiary designation on another 529 plan earmarked for his oldest to his middle son.
Parents who send their children to private school should also be aware of the rule change brought by the Tax Cuts and Jobs Act that allows parents to use up to $10,000 per year from a 529 plan to pay for private school tuition.
[10 Ways to Maximize Your Retirement Investments.]
“This isn’t a big benefit for younger children, but for parents with kids in their junior or senior years of high school with some college planning clarity, it may make sense to use 529 money for this expense,” he says.
Compare State Plans
“With a relatively short period of time to invest 529 funds, funds lost to fees have little time to recover,” says John Madison, a personal finance counselor and certified public accountant at 60 Minute Finance in Virginia.
Some, but not all states, may offer a tax incentive for using its own plan, such as a deduction, and this could negate slightly higher fees than other private or out-of-state plan options, Madison says.
But if your state doesn’t offer any special incentives, you probably want to explore other options, Yudina says.
“The first screen for plan selection should be low total internal and external fees expenses,” Robinson says. “This screening criteria will likely eliminate all of the broker-sold plans from consideration.”
He suggests looking at New York NY Saves and Colorado Direct plans, both of which feature low-cost Vanguard funds.
“Other factors to consider include historical returns, investment management fees, as well as stability and reputation of the investment firm,” Yudina explains.
Also, some states limit the state tax deduction amount for 529 contributions to one per household per year or one per beneficiary per year, but others don’t. So you may want to consider opening two accounts per child (one with each spouse as owner) to maximize the state tax deductions in states that allow it, Solomon says.
See: [8 Best Gifts to Give for an Investment Education.]
Diversify and Rebalance
If you decide to choose your own funds in the 529, remember to rebalance it as your children get older.
“When you children are young — through elementary school — the 529 portfolio should lean toward equity funds as the returns are historically higher than bonds, and you have time to let the balance fluctuate but grow over time,” Madison says.
When the beneficiary child enters eighth grade, begin to move a quarter of the 529 balance to a short-term bond fund or money market fund if rates have improved by then, he adds. Each following year, move another quarter of the 529 balance to a short-term bond fund.
“Following this schedule slowly removes market risk from the account so that funds needed within five years will be in safe, stable investments,” Madison says. “Remember that equity investments should not be used when they will need to be used within five years, whether planning for college expenses or retirement.”
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Why You Shouldn’t Coast With 529 Investments originally appeared on usnews.com
