Although 529 plans come with risk, you can mitigate that risk and increase your odds of returns by taking the right steps. Learn more from the 529 experts at Sootchy.
As investments in your child’s future go, a 529 plan is one of the most effective options out there, not only because it comes with tax benefits but also because it can generate sizeable returns while your child grows to college age. However, as with any investment, risk is part of the equation when opening and managing a 529 plan – risk that carries added weight, thanks to the purpose of the funds at stake. Naturally, those considering a 529 plan want to know if a 529 plan can lose money, but the answer isn’t a straightforward one. Here, the experts at Sootchy will discuss the role of risk in 529 investments and how you can guard your gains against a volatile market; keep reading to learn more.
Although 529 plans are largely defined by what makes them similar – the tax breaks, the investment returns, the limits on distributions – these savings options can also differ significantly from state to state and owner to owner, especially when it comes to rates of return. Even if you compare the performance of two different account owners under the same plan, you might see some discrepancies, because the way one person invests could be more aggressive or conservative than the strategy employed by another; in addition, some plans change over time as the beneficiary ages, and the risk of losses changes with them.
This type of shifting 529 investment portfolio is called an age-based portfolio, and it’s the most common type among those with one of these accounts. Essentially, the thinking behind using an age-based portfolio for a 529 plan is that, when the account is first opened and the beneficiary is young, time is on your side. Even if you lose money through the plan, you still have a decade or longer to make up those losses, so making investments that come with greater risk – and which may therefore offer greater returns – can be justified. Once the beneficiary gets closer to college age, however, the investment must be protected, as there likely isn’t time to recoup lost funds. It’s for this reason that most age-based portfolios get more and more conservative as time goes on, moving funds into safer investments like bonds or money markets.
While the risk of loss in a 529 plan is automatically mitigated over time in an age-based portfolio, static portfolios can carry more or less risk depending on the whims of the plan owner. Basically, static portfolios are those featuring custom investments chosen by the owner, making them a great option for experienced investors who would rather not leave their returns up to chance. However, this also means that a plan owner can set themselves up to lose money if they make a poor investment; ultimately, the safety of a static portfolio relies on the knowledge and luck of the person controlling the account.
When managing a 529 plan, the likelihood of losing money will depend on the nature of this strategy and the kind of investment portfolio you maintain. The safest kind of 529 plan is often a prepaid tuition plan, because they are managed by a state administrator who oversees their growth, and many of these plans feature principal protection or returns guaranteed by the state. In some cases, the state offering the plan may even make up the difference between the money in the account and the cost of tuition, though this only applies to those who sign a contract that guarantees in-state tuition rates in the future.
With these plans, a state guarantee makes it impossible to lose money, but you might not gain much, either, which can all but negate the entire purpose of opening a 529 plan. The same thinking applies to college savings plans, which tend to offer more flexible investing options: The lower your risk, the lower your rate of return.
Whether you’re a plan owner with a static portfolio that’s losing money or someone with an automated age-based portfolio who wants to choose investments manually, there may come a time when you want to switch your investment options to improve the performance of your 529 plan. If so, it’s important to note that you can only make two of these changes per year, though there are some caveats.
The first point to note is that you can reallocate funds from several investments at once and still count it as one change, but only if all transfers are made at the same time. In addition, it might be possible to get around the two-per-year limit by incorporating a beneficiary change; if you switch beneficiaries at the same time that you change investments, it won’t be counted toward your two for the year. For families with multiple children, this may simply mean moving the 529 plan from one to the other, then back again – an easy workaround.
Picking a college savings plan for your child or children can require weighing a lot of factors, but one of the most important is whether the plan could realistically provide the kinds of returns necessary to outpace the rise of college tuition. Unfortunately, with these returns often comes the risk of losses, but with the help of the experts over at Sootchy, you can find a safe, productive plan for your family. Learn more by visiting us online or download the Sootchy app today.