Now, that I have opened a 529 college savings plan for my child, how do I invest it?
That is a question that advisors at Yeske Buie often hear from their mostly high-net-worth clients.
This year, the firm offered a webinar for clients and the public to offer insights into making the best use of 529 plans from the time a beneficiary is born through college graduation. The plans allow investors to save tax-deferred money toward college expenses, not only for their children but for anyone in their family.
“We think it's very important to be globally invested and very broadly diversified,” says Lauren Stansell, a CFP and financial planner with the firm in San Francisco. “There are two phases we think of: the accumulation phase and the spending phase.”
The overall accumulation target should be to save half of tuition and expected expenses into the plan, Stansell says.
Why not aim to save the entire amount for a family member's education?
"Additional savings should occur in taxable accounts to preserve flexibility," given that funds not saved inside the plans, while subject to taxation, can be used as needed for other purposes, Stansell says.
"It’s hard to know what the child may choose to do in the future,” she says. “If the child chooses not to go to college, the funds can still be withdrawn [from a 529], but taxes and penalties are assessed … Should the child choose not to go to college, those funds can be redirected to other planning strategies and goals with no penalty."
Regardless of how much money clients save in their plans, students still should "apply for grants and scholarships to preserve savings," Stansell says.
Next, Yeske Buie, which is also based in Vienna, Virginia, breaks the accumulation phase for college savings across a 529 plan and funds invested in non-tax-deferred accounts into four stages of a child's age, each of which follows a different investment allocation. Over time, the investment strategy becomes more conservative in much the same way that a typical retirement plan does, as follows:
- Up to age 6: Funds are invested 100% in stocks, nothing in bonds.
- Age 7 to 12: Allocation shifts to 90% stocks, 10% bonds. “We still have a lot of time to grow the funds," Stansell says.
- Age 13 to 15: 80% stock and 20% bond allocation. "We are getting closer and closer,” Stansell says.
- Age 16 to 18: 70% stocks, 30% bonds
The firm uses U.S. and international stocks, large company stocks, as well as small company and value stocks, Stansell says.
"We accomplish this with mutual funds, because you just can't be diversified enough without them," she says.
Once the child enters college, the plan is in the spending phase, and the money management strategy becomes more conservative than it was at the end of the accumulation phase, as follows:
- Funds for the current year's spending needs are kept in cash.
- Funds for the remaining years in college are invested in bonds.
- Excess funds in the account above the amount needed for the college years are invested in stocks.
- The categories are rebalanced regularly. "As the cash is spent for the first semester, bonds can be sold to replenish the cash back to one full year’s worth of needs," Stansell says. "Because the remaining bonds still cover the remaining expected expenses, stocks don’t need to be sold to add to bonds. But, if expected expenses increase, stocks could be sold to add to the bonds to achieve the desired allocation of funds."
To simplify this plan, Yeske Buie suggests that clients put their family college savings into Utah's 529 plan, called My529.
"One of the reasons is that the Utah 529 offers [Dimensional Fund Advisors] funds that we like, and they offer portfolios that almost directly align with the portfolios that we build at Schwab,” Stansell says.
Keep in mind that this 529 roadmap is general and won't apply to everyone, she says.
"So, it’s important to us to have a deep discovery process with our clients and work with them as circumstances arise and change," Stansell says. "Every situation is different, and this is one facet of planning we do with our clients."
This story is part of a 30-30 series on tax-advantaged investing.
