New losses for college savers
For the second time in 3 years, the markets are taking their toll on 529 plans -- even for soon-to-be freshmen.
This post comes from AnnaMaria Andriotis at partner site SmartMoney.
The back-to-school blues just got a little worse. As colleges are about to send tuition bills, the markets have taken yet another toll on the most popular college-savings accounts in the country: 529 plans.
For the second time in three years, the popular state plans are taking losses that, while less than the broad market, are hitting teenagers starting college this year or next. In at least 14 state plans, at least some investment portfolios intended for students 17 and older are now in the red, wiping out a chunk of money that parents may have earmarked for this year's tuition.
In some states, those accounts are down as much as 5% since the beginning of July, better than the 12% loss of the Standard and Poor's 500-stock index but still unpleasant for parents with tuition bills due this fall. "How heartbreaking would it be to be at the beginning of the school year and looking at losses that are material," says Laura Lutton, editorial director for Morningstar's Fund Research group, which grades 529 plans.
In most of these states, the losses have hit the same portfolios that suffered when the market fell in 2008 and 2009 -- so-called age-based funds, which are premixed portfolios of stocks, bonds and money market funds designed to get more conservative as matriculation nears. During that period, some funds designed for soon-to-be college freshmen lost more than 25% over 12 months. Post continues after video.
Riskier funds are more popular
In response to that crash, many states added ultra-safe investments, like certificates of deposit, to their plans, but the age-based options remain the most popular choice. They currently hold more than half of the $150 billion in 529 plan assets, says Lutton.
Parents like them because they adjust on their own, says Mark Kantrowitz, the publisher of FinAid.org and FastWeb.com: "The idea is that you don't have to make decisions."
From state plan to state plan, the risks vary. In general, the amount invested in stocks for students who are about to enter or are in college is between 0% and 20% in age-based options, says Joan Marshall, chair of the College Savings Plans Network, the national association for all 529 plans. But some states have much more of their assets devoted to stocks.
Right now, the more stocks in a fund, the deeper the losses. In Iowa, for example, one of its four age-based options for 16- to 18-year-olds has 60% exposure to stocks, 40% to bonds: It has lost 4.3% year-to-date. Longer-term, the returns are still up 13.5% for the past year and 4.4% for the past five years, though current losses are eating into gains.
"It absolutely should be a concern and parents need to be comfortable with how much risk they want to take," says Michael Fitzgerald, Iowa's state treasurer. He points out that the plan offers more conservative options for the same age group, including one with no stock exposure.
Other states say no one is forced to choose the riskier options. Many offer several different age-based options for students, including some that hold no stocks as college gets close. For most of those, quarterly and year-to-date returns are up slightly.
"I don't feel it's my job to create 529 plans that will protect investors from losing their money," says Scott Gates, director of the Learning Quest program at the Kansas Treasurer's Office, where quarterly losses on a variety of age-based options for 17-year-olds range from 1% to 3% as of Aug. 9, according to data from Morningstar. "When an investor picks a plan, they have to make that decision to pick the portfolio that's right for them," Gates says.
Enough time to recover?
That's a big decision, and not only for students heading to college in the fall. Plans earmarked for younger students -- ages 14 through 16 -- have even higher allocations to stocks, and have suffered losses about double that of older students in several states. The same families were also heavily exposed to equities back in 2008. "Eighth-graders, freshmen and sophomores are probably in more of a pinch," says Stacy Auman, vice president and investment officer for First National Bank of Omaha, the program manager for three Nebraska 529 plans.
Not only are they suffering deeper losses than their older siblings, but as their portfolios get marginally more conservative over the next few years, it will be hard to recover, even if the stock market zooms. (How much should you be saving for college? Try MSN Money's calculator.)
The logic behind investing money earmarked for college in the stock market is reasonable. To save $110,000 -- the average cost of four years of tuition and fees at a private college today -- in a savings account earning 1% interest, parents would have to save more than $450 per month for 18 years. Investing in a 529 plan, on the other hand, offers the potential to earn a market rate of return -- historically 6% to 7% per year over time -- which can help parents cover the same bill with just around $250 to $280 in monthly contributions.
But with investing comes risk, and while the losses aren't yet as severe as they were during the last crash, there are other factors that make the environment comparable, says Kantrowitz. Tuition costs are already rising. Strapped states reneged on promised tuition aid just a few weeks ago. The cumulative effect, for parents, may be less money across the board.
Options are limited
Parents who would like to choose a different portfolio may not have many options. They can choose a different option within their plan -- if they haven't done so yet this year. Savers can only make one such change each year, and though the Internal Revenue Service allowed two changes in 2009 in response to the market turmoil, there are no plans to do so now, says Joe Hurley, founder of SavingforCollege.com, which tracks 529 plans. Separately, parents could choose an entirely new plan, though going out-of-state may mean giving up a tax break.
There are fewer limits on new contributions. Parents who are still contributing can choose a more conservative option, including a CD or money market fund, says Hurley. Or, they can cut some of their losses and withdraw for this year's college tuition now. As long as they pay the bills before the end of December, they'll avoid taxes and penalties.
Still other parents might be better off not making any withdrawals at all, says Sheryl Garrett, a certified financial planner: If they can use their current income to pay for college, that could potentially allow their savings time to recover.
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