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Rethinking 529 College Savings Plan

By: John Pitlosh

By: John Pitlosh CFP, MST

A conversation around dinner table USA…

Parents “Son….you know how you wanted to go to M.I.T., so you could become a scientist and start your own business to develop those fuel cells that can collect and store the unused energy from cell mitosis…”

Son “Yes indeedy I do! All that money I saved up from my internet paper routes which you and grandpa matched and doubled…I should be home free with that tax free 529 savings plan you guys picked…Right?”

Parents “Well………We wanted to talk to you about that ……..You see the market was down BIG last year and…And…Well…Unless you want to wait around for the market to bounce back, you are going to have to keep your paper route or take out loans while you go to school because your dad and I saw how long it would take to retire after we pay for college and…We took a shot, but we just can’t do both…SORRY.”


Real households all across the country are becoming increasingly split over the difficult choice between saving for retirement and saving for their children’s college education. As families are forced to make tough choices in tough times, they need to be more efficient with the dollars that they put towards college. As a result, families should review their current approach to college savings to make sure they are getting the most out of their current plans. While 529 savings plans contain a lot of good qualities, they also contain individual investment risk for the parents, and when markets go bad, this can severely hamper a family’s ability to pay for college. Given the wide variety of risks and methodologies that people use to pay for college, it is important that the savings strategy or strategies you employ fits appropriately within your personal circumstances and takes the appropriate risks.

529 Background

Savings Plan – When families think about saving for college, the first program that usually comes to mind is the 529 savings plan. The 529 savings plan operates under the assumption that when you take your dollars and invest them through a state administered investment program, over time, you will have more money as your investment portfolio grows. When you add in tax free growth for college expenses, potentially long time horizons for your investments to grow, and the flexibility of school choices and expenses, it’s easy to see why these programs have garnered a lot of attention. In spite of these benefits, the savings plan does have some cracks in its armor. As many participants in these types of plans are acutely aware, equity investment is a sword that has two sides and it cuts deep both ways. Timing the exposure to equities in a 529 savings plan is a game of luck where the odds only improve by increasing the amount of time that you are exposed to the market. In addition to potentially poor investment performance, other unfavorable aspects of 529 savings plans include the manner in which you have to take losses, the limited investment plan options, the limited number of times that you can change the allocations inside a plan, and the various layers of bureaucracy and costs that can include sales commissions, state administrative fees, and investment manager fees which can eat into the overall performance results. When it’s all said and done, the positives should outweigh the negatives, but there is no guarantee that your investment results will keep pace with the rising costs of college tuition.

Prepaid Plan – On the opposite end of the spectrum are the pre-paid 529 programs. The easily misunderstood state and independently sponsored programs allow families to pay for college tuition now and shift the risk of rising tuition costs over to the plan sponsors. Most pre-paid programs have been around for much longer than the savings plans, but The New Independent 529 plan is a relative newcomer that was started by a collective group of private colleges back in 2003. Not every state has established a pre-paid program, and the ones that do can open and close their plans based on their ability to support its program’s obligations. Program eligibility and benefits can vary widely from state to state, so you need to be aware that the devil really is in the details of each program’s contract. Some plans, like Florida, offer additional features that allow you to prepay dormitory expenses, while other plans like The Independent 529, offer tuition discounts. You should also be aware, that not all plans are backed by tax payer support; some have limited refunds, while others have limited ability to transfer the contracts. While the idea of transferring tuition inflation risk is a great fit for a lot of families, you need to understand who you are transferring that risk to and how your obligations are met should there be shortfalls or a change in plans.


Recent market volatility and the associated long term performance history of college 529 savings plan investments has lead people to reexamine their place in the college savings tool kit. The conundrum for families is that markets go up and go down, but college inflation moves in one direction…UP! Unlike the synchronous movement of gas and oil prices, matching up market risk to tuition inflation can explode in your face during a market downturn. In tough economic times, state budgets and college endowment funds lose tax revenue and investment dollars, and as a result, colleges experience a downturn in funding. When this happens, colleges are faced with the choice of cutting costs and/or pass on the tuition increases to incoming students. As we are seeing in our home state of Florida, tuition increases can hit double digits quite easily.

When you examine the goal of paying for college, and match it up with the biggest component of college savings risk, tuition inflation, the 529 savings plan acts like a hammer trying to drive a screw into a piece of wood. If you swing hard enough and with enough momentum, you can drive the screw into the wood in spite of the threading. If you take that same hammer and swing too light, the screw either doesn’t move or the threading causes you to enter awkwardly as it takes out a divot as it goes whizzing past your head. The same analogy applies to the 529 savings plans when you front load your investment and give it the maximum amount of time to work, refer to tables 1 and 2. As you can see from these tables, frontloaded investing makes a big difference. In spite of how bad the markets performed during the tech bubble and during the current financial crisis, you can still see that a front loaded investment in the S&P 500 still outperformed a level 6%.

On the other hand, when you are funding a plan via periodic installments and your investment dollars are not gaining the time they need to level out market volatility, your investment return can be a crap shoot. Looking at table 3, you can see that the installment method into the market would not have worked in your favor for the 18 year period ending in 2008. Every subsequent year that you put money into the market, your dollars have less time to work, so the overall performance of the plan will be magnified by market volatility in later years. Several plans have age based allocation programs, where you dial down the risk as your child grows older. The problem with utilizing these options is that the equity performance window becomes even more compressed as you progressively dial down the equity exposure and risk as the beneficiary approaches their college enrollment. Because of how the age weighting options function, you could end up with the worst of both worlds, poor equity performance and little or no opportunity for the investment to come back. Since we can never predict when a year like 2008 will occur, an initial more predictable investment option, like that in table 4, might be the better approach from the start when funding a savings plan via installments.

This past year has both illustrated and magnified several of the risks and flaws of using a college 529 savings plan as the core vehicle for college savings. In situations with limited resources, try to limit the scope of your schools to those within the parameters of a pre-paid program and target your secondary savings for a 529 savings plan that can cover a broader range of college expenses. When money isn’t an issue and estate taxes come into play, a front-loaded 529 saving plan can be a powerful tool. If your savings plan performs well, you could also consider rolling a portion of your savings plan into a prepaid tuition plan to “lock in gains” as it is possible to change programs mid-stream. Saving in the most cost effective and risk averse manner by matching your investment to the main risk, TUITION INFLATION, will lead a lot more people down the road of prepaid tuition plans, but you need to remember that these programs have a downside as well.


When you are faced with the dilemma of choosing between Retirement or College, in almost every case, it is going to make more sense for the parents to utilize their current cash flow to secure the steps to their retirement before funding college for their children.


You probably don’t want to burden your children down the road. Like you, they may have children that they need to send to college and they may have another set of parents that they may need to help out as well.

An investment in your child’s college education doesn’t mean he or she will move out after college, drain your assets further, or become a money making machine. I have dealt with people that have 0 college education that are multi-millionaires 10 times over, and I have also met JD MBA’s from top tier schools that are bartenders.

Accessible, reasonable, and quality financing is available for college and it is one of the few conduits to credit that you don’t need a job in order to get a loan. Having children take out loans can also help them create credit history, gives you the flexibility to help out when cash flow permits, and they are more likely to have the ability to utilize the low income thresholds of education tax benefits that a lot of parents make too much to qualify for. On the other how would you like to be 80 right now and have to do a reverse mortgage?

As you look past your own personal issues and options, you will ultimately have to boil it all down into risk. On the one side, you have the risks that you feel comfortable taking on yourself and on the other side you have the risks that you feel comfortable shifting to someone else. When you have to make the risk-reward decision between college and retirement, invariably retirement is the better choice for more reasons than I have listed above. However, when you do get over the retirement hump and start to save for college, you will want to match your investment strategy to your particular circumstances and risks. Unfortunately every family is a little different in terms of their values, risk tolerance, resources, savings entry point, and children’s aptitude, so the more popular 529 savings plan isn’t always the most appropriate answer as the solution(s) will depend on a combination of factors.

Additional Resources:

Publication 971 at IRS Homepage – If you want to learn more about the tax benefits for education expenses, you should check out the IRS Pub 971. Its easy to read and they give lots of examples. A useful tidbit from this publication is how to take a loss from a qualified tuition plan.

FinAid! – A multi-dimensional website that is an excellent resource for parents wanting to learn more about funding college and the various forms of financial aid available.

The College Board – This is another good multi-dimensional website. The organization does a lot of research on trends and costs of college. They also administer AP testing and CLEP testing…if you don’t know what that is you should check out their website.

MorningstarAdvisor (Susna T. Bart’s Column) – While you may not be able to get access to the column, she does have a book out on estate planning with 529’s that is well regarded.

Bank Rate/Joe Hurley’s Saving for College website – Joe’s website is an amazing resource that has a lot of free content.

The Independent 529 plan – This is the 529 pre-paid tuition program that was set up by private institutions.

Upromise – This is a card rewards program that helps you save for college through your ordinary every day shopping.

Ivywise – The founder of Ivywise has written a couple of books on helping kids find the right colleges, get accepted, and get through in 4 years.

Table 1: Frontloading with Unpredictable S&P 500 Returns (1991-2008)

When you invest early and over a longer period of time in the markets, you are able to benefit from the compounding returns that accumulate over longer periods of time. In the table below, you are able to see that $90,000 invested 18 years ago still garnered a higher return, in spite of the tech bubble and our current financial crisis.

Year Investment Annual Annual Accumulation
Performance Return
1 $90,000.00 $27,423.00 30% $90,000.00
2 $ $8,947.63 8% $117,423.00
3 $ $12,738.16 10% $126,370.63
4 $ $1,836.24 1% $139,108.79
5 $ $52,967.14 38% $140,945.03
6 $ $44,522.23 23% $193,912.17
7 $ $79,541.72 33% $238,434.40
8 $ $90,877.58 29% $317,976.12
9 $ $86,022.82 21% $408,853.70
10 $ ($45,033.76) -9% $494,876.52
11 $ ($53,486.30) -12% $449,842.75
12 $ ($87,594.78) -22% $396,356.45
13 $ $88,583.72 29% $308,761.67
14 $ $43,231.18 11% $397,345.40
15 $ $21,632.31 5% $440,576.58
16 $ $72,982.78 16% $462,208.89
17 $ $29,382.02 5% $535,191.67
18 $ ($208,892.27) -37% $564,573.69
$90,000.00 $265,681.43 $355,681.43

Table 2: Frontloading with a Predictable Return

This table reinforces the benefit of frontloading a 529 even if you are getting a lower overall rate of return. When compared to table 1, this table illustrates that in spite of horrible markets, investing in the market over long periods of time should still create a better result than a long term low volatility option.

Year Investment Annual Annual Accumulation
Performance Return
1 $90,000.00 $5,400.00 6% $90,000.00
2 $ $5,724.00 6% $95,400.00
3 $ $6,067.44 6% $101,124.00
4 $ $6,431.49 6% $107,191.44
5 $ $6,817.38 6% $113,622.93
6 $ $7,226.42 6% $120,440.30
7 $ $7,660.00 6% $127,666.72
8 $ $8,119.60 6% $135,326.72
9 $ $8,606.78 6% $143,446.33
10 $ $9,123.19 6% $152,053.11
11 $ $9,670.58 6% $161,176.29
12 $ $10,250.81 6% $170,846.87
13 $ $10,865.86 6% $181,097.68
14 $ $11,517.81 6% $191,963.54
15 $ $12,208.88 6% $203,481.36
16 $ $12,941.41 6% $215,690.24
17 $ $13,717.90 6% $228,631.65
18 $ $14,540.97 6% $242,349.55
$90,000.00 $166,890.52 $256,890.52

Table 3: Installment Funding with Unpredictable S&P 500 Returns (1991-2008)

When you invest the same $90,000 in $5,000 annual installments, you lose the benefit of compounding returns that accumulate over longer periods of time. As a result your exposure to the market gets compressed and the overall performance can get magnified (Positively or Negatively) by the last few years of market performance. During this time frame, the impact of market volatility has had a highly negative effect.

Year Investment Annual Annual Accumulation
Performance Return
1 $5,000.00 $1,523.50 30% $5,000.00
2 $5,000.00 $878.09 8% $11,523.50
3 $5,000.00 $1,754.08 10% $17,401.59
4 $5,000.00 $318.85 1% $24,155.67
5 $5,000.00 $11,076.53 38% $29,474.53
6 $5,000.00 $10,458.52 23% $45,551.05
7 $5,000.00 $20,352.79 33% $61,009.57
8 $5,000.00 $24,682.36 29% $86,362.37
9 $5,000.00 $24,415.81 21% $116,044.73
10 $5,000.00 ($13,236.91) -9% $145,460.55
11 $5,000.00 ($16,315.89) -12% $137,223.64
12 $5,000.00 ($27,825.61) -22% $125,907.75
13 $5,000.00 $29,574.26 29% $103,082.13
14 $5,000.00 $14,977.02 11% $137,656.40
15 $5,000.00 $7,739.80 5% $157,633.41
16 $5,000.00 $26,901.93 16% $170,373.21
17 $5,000.00 $11,104.91 5% $202,275.15
18 $5,000.00 ($80,800.62) -37% $218,380.05
$90,000.00 $47,579.43 $137,579.43

Table 4: Installment Funding with a Predictable Return

This table illustrates the point that a more predictable return with less volatility is probably a better choice if you are funding the plan via installments. When compared to table 3, this table illustrates that because bad markets happen in an unpredictable manner, compressed exposure to the market is a risk that you should probably avoid

Year Investment Annual Annual Accumulation
Performance Return
1 $5,000.00 $300.00 6% $5,000.00
2 $5,000.00 $618.00 6% $10,300.00
3 $5,000.00 $955.08 6% $15,918.00
4 $5,000.00 $1,312.38 6% $21,873.08
5 $5,000.00 $1,691.13 6% $28,185.46
6 $5,000.00 $2,092.60 6% $34,876.59
7 $5,000.00 $2,518.15 6% $41,969.19
8 $5,000.00 $2,969.24 6% $49,487.34
9 $5,000.00 $3,447.39 6% $57,456.58
10 $5,000.00 $3,954.24 6% $65,903.97
11 $5,000.00 $4,491.49 6% $74,858.21
12 $5,000.00 $5,060.98 6% $84,349.71
13 $5,000.00 $5,664.64 6% $94,410.69
14 $5,000.00 $6,304.52 6% $105,075.33
15 $5,000.00 $6,982.79 6% $116,379.85
16 $5,000.00 $7,701.76 6% $128,362.64
17 $5,000.00 $8,463.86 6% $141,064.40
18 $5,000.00 $9,271.70 6% $154,528.26
$90,000.00 $73,799.96 $163,799.96