I’ve written about 529 plans (tax advantaged accounts used for education savings) a few times in the past (you can find those posts by searching archives on the blog if interested). This week, I talked to a client about how to best invest funds within those accounts.

Reminders Before Diving In

Just a reminder about 529 plans before we start discussing the investment approach. The main advantage of these accounts (ie: why you would save for education in this manner vs. in another account) is the tax structure. Not only is there sometimes a state tax deduction for contributions (varies based on your state of residency and the 529 plan you select), but you will also not pay taxes on the growth/earnings within these accounts if the funds are used for eligible education expenses.

Due to these tax advantages, these accounts tend to be the most powerful when you fund them “early and often” as it gives the funds a longer time frame to grow – and if you invest the accounts in assets that are most likely to experience growth during their lifetime.

Investment Options

Much like employer run retirement plans, you do not have unlimited options for investment within a 529 plan. The options are set by the specific plan for each state by the underlying money manager for that state (TIAA runs WI’s plan, Vanguard runs Nevada’s plan, etc). The options typically include index funds, active management funds, age-based portfolio, a stable value/cash option, and perhaps a few others.

A great place to start the investment process is to obtain the menu of available investments for your given plan so you can review the performance, composition, and expenses of each and line those up against your objectives.

Considerations for Investing

There is no “one size fits all” approach to investing within 529 plans. However, here are some general considerations:

*Seek growth early on – again, given that the benefit of these accounts is no taxation on growth/earnings, if you have a meaningful time horizon (over 5 years) before these funds will be used, it is wise to focus on asset classes that are more predisposed to growth (such as equities)

*Adjust over time – as your child ages, you may wish to scale back the growth and focus instead of capital preservation. This prevents you experiencing a market downturn at the same time you need to take a distribution. You can certainly do this yourself by adjusting the asset mix over time. Alternatively, you can opt for the aged-based/enrollment year investment which will automatically adjust the asset mix over time. Be sure to review the underlying mix and ages at which is adjusts as it may not line up with your expectations but it’s not a bad place to start

*Safeguard distributions – Eventually, you are going to need to make distributions from these accounts to pay for your child’s education. Based upon the cost of their school, other sources of funds, and timing of payments, I typically suggest at least one year (but perhaps even more) of distributions be placed in “safekeeping” such as the stable value option within the plan. Again, this is to guard against a market downturn bringing your balance down at the exact time you need to take a distribution

*Evaluate performance – 529 accounts are investment accounts, just like your 401k and after-tax savings. And given the ever-rising cost of education, they may need to grow to become a rather meaningful balance. Keep an eye on performance against a relevant benchmark (and better yet, against your return objective to meet the needed level of education funding) and adjust as needed

*Pay attention to rebalance limits – most plans limit the number of times you can rebalance the account in any given year. Ensure you understand those limits and act accordingly!

Hopefully this gives you some general background on this process but as always, everyone’s situation is different so reach out to your advisor to formulate a plan built for you!