529 Asset Allocation as College Approaches

[upupandaway]

My DD is a freshman in high school this year. The 529 I have for her is 100% in Vanguard Total Stock Market. I believe now would be the time to start changing the AA to be more conservative to protect against a market correction when we need to withdrawal for her first year of College. Would changing the AA to something like 75% Total Stock Market and 25% Total Bond Fund and then shift by 25% each year be too simplistic or would that make sense? Both of my kids 529s are not over funded, and we assume they will be fully consumed over a normal 4 year undergraduate degree. I'm not sure that matters but I thought I would add it in. Thanks for any advice you have.

 

[Koolau]

If you are paying for her college, then I suppose you could just think of the 529 fund as being part of your overall asset allocation in which you could make a case that any one chunk of your portfolio is just a part of the whole. As such, the allocation within the 529 wouldn't really matter. (Responsible replies by differing opinions are welcomed. - Boiler plate for editorials. )

 

[upupandaway]

If you are paying for her college, then I suppose you could just think of the 529 fund as being part of your overall asset allocation in which you could make a case that any one chunk of your portfolio is just a part of the whole. As such, the allocation within the 529 wouldn't really matter. (Responsible replies by differing opinions are welcomed. - Boiler plate for editorials. )

I think the major difference is these funds have to be used for education (other then the few carve outs) and thus have a much shorter time for when I need to withdraw them. It's like they have their own SORR.

I like your disclaimer at the end by the way.

 

[FlaGator]

I'm on the second kid paying for college from a 529. What I have done is guesstimate what I expect to spend for 4 years, including withdrawals for any scholarships received, and put that into short term funds. And I did that one year ahead of enrollment to ensure there was adequate money. Took some risk off the table.

I think your approach is prudent, but has some risk of extended down market years. I would focus on cash needs, and suggest you do the rebalance on a $$ basis rather than a strict percentage. IOW, move one's year's future estimated expenses to cash/ST investments each year. This gives you some market exposure with a 4 year window.

Since you're not overfunded, a conservative approach would be to move the full 4 years to cash now. Safe bet, covers your costs, and no risk or anxiety compared to moving the allocation to cash/ST incrementally over the next few years if the market doesn't move your way.

Great to have options!

 

[SecondCor521]

I think the simple plan in the OP is fine. I did something similar with my three kids' 529's - in my case I figured what expenses they needed for the next 4 years and put that in bond funds, left the rest in stock funds, rebalancing periodically as their plans evolved. Worked fine. Have some leftovers, which I'm working on shifting to their Roth IRAs via the new 529->Roth rollover law, which is also working fine.

 

[tulak]

I used a Vanguard Target Retirement fund for both kids, with a date close to when they started college. That way rebalancing happened automatically. But we were (intentionally) underfunded.

If you are not overfunded and have enough to pay for four years, then why not sell it all and setup a 4 year ladder of treasuries and consider it done?

What is your plan if there is an extended downturn in equities?

For me, minimum recovery time is 5 years, but it can take longer. Would that affect your ability to pay for college? If so, then is it worth the risk?

Otherwise, I think your plan is fine. I tend to be overly conservative for cash I need within 5 years and in this case, you know college is paid for, so why risk it.

 

[SecondCor521]

you know college is paid for, so why risk it.

I agree with the overall tenor, but I did want to point out that the OP doesn't know college is paid for.

Their DD is just a freshman in high school. Risks to funding:

1. Kid decides to go to a more expensive school.
2. College costs rise faster than inflation.
3. Kid decides to change majors and needs a fifth year.
4. etc.

Of course, the above reflects my family's approach of paying for "a college degree". OP could decide that the kids get whatever is in their 529, and if it runs out, too bad. That approach solves my list of risks above.

 

[tulak]

I agree. I assumed, likely incorrectly, that OP’s comment on not being overfunded meant there will be enough for four years.

As you point out, there are other factors at play. I was focused on market returns, but it’s also a good opportunity to communicate what you are willing to pay. With our kids, we committed to four years in-state tuition with room/board, so we had a good idea of overall costs.

Even though the way it worked out was different. One went to a cheaper in-state university (what a bargain!) and the other to a private university which was about 30% more after scholarships.

And as a side benefit, both quickly appreciated that they had a full ride and time to focus on their studies. Many of their peers had student loans and had to work.

 

[all4j]

It's like they have their own SORR.

This comment is spot on & tells me you’re probably going to make as good a decision as any. Keeping things simple is usually as good as overthinking. That said, I’ll offer a few things just in case they may prompt thoughts…this without knowing your risk tolerance (financially & mentally in case of adverse sorr) &/or which capabilities are available in your plan.

I’d compare Total Bond to both a short term bond & a money market. Total bond probably has a duration toward the midpoint of college years, but not giving you the additional performance. Look especially at time periods of fed raising/cutting rates.

Since you’ve been 100% stock, you haven’t been rebalancing or changing allocation. Allocation changes are likely limited. Are you adding additional funds still or was there a lump sum? You may be able to direct future $s differently than current allocation. Pulling those together, let’s say you’re looking to start with 75/25. Perhaps, change allocation to 70/30 with new $s all going to bonds (or mma). If stock don’t take a downturn & outperform bonds, it will drift toward 75/25. If they don’t outperform, then you had less at risk there anyway.

Good luck!

 

[Closet_Gamer]

I subscribe to the theory that if you need the money in the next few years, it doesn’t below in the stock market.

My kids are just about done with college but I’ve made some commitments to help nephews who will start heading into college years soon. That money is in municipal bonds (it’s outside of a 529). I may bleed a couple points of absolute value but I know it will be there for them.

 

[bloom2708]

I went "Interest only" before the start of each (3) kids freshman year of college.

They had enough and there was no need to risk losing 20-60% of principle to have "more".

You can have different outcomes:

Much more
Some more
A litle more
The same
Some less
Much less

Some are worse than others. Protecting against Much less was good enough.

 

[sengsational]

I'm fine with one AA across my own tIRA, 401k, Roth, and that same set in DW, but not the 529. The reason, in my case, is that account is going to zero in 4 years. Let's say the market tanks and you sell to pay tuition. Normally I'd say "no problem" and buy the same quantity in another account so I didn't end-up "selling low". And you can succeed an not selling low, certainly. The problem is the magnitude of the tax advantaged funds will be reduced. That means paying the rest of the education expenses with funds that have been through a tougher tax gauntlet.

Given you can get 4.5% on money, that's where I'd go with it. You could buy various maturity bonds if you want to tinker, but I'd get out of total stock market with a kid that's poised to drain the account.

 

[upupandaway]

Sincerely thank you all for your time and ideas. I generally look at a 5 year recovery period for money I need as well and that is what triggered this rebalancing for me. My kids will be helped by their grandparents for 25K a year for college as is the tradition in our family. They have no in-state mandate from their Grandparents but I wish they did. I'm saving for the overage in their 529s. Some risks as I see right now.

1. Daughter keeps declaring she does not want to go to school in our home state. I'm working on a regular basis to convince her of the financial implications of out of state tuition. She is normally reasonable but still young and learning.
2. Daughter has the aptitude and could potentially get into a more expensive University
3. Obviously selling in a down market in the 529s to cover costs is not ideal. (I had not considered purchasing in another account to counter this)
4. My own liquidity if I need to cover a gap. I'm heavily in the market and other illiquid investments. I don't have a solid plan for this right now if the 529 funds do not cover the difference between Grandparents contribution and actual costs. Niece who it the first one through college went out of state and lived in a really nice apartment with a pool and has needed to take loans. This is the scenario I would like to avoid.

I am still contributing to both my kids 529s for about $4,000 a year. On campus in our state is around $35K according to the college website. This leaves a gap of $40K I need to cover over four years. I'm set to have this covered with contributions alone and no growth. Perhaps I should move the money out of the market as suggested by others and up my new 529 contributions to cover a potential gap. I intend on carrying on the tradition of helping with Grandchildren's college so I can let any excess 529 funds ride until that time.

Thanks again for all of the help.

 

[bloom2708]

Always check with the interested schools. Kid 2 is a senior at Kansas University in Lawrence, KS.

With her grades, the scholarship she has had brought tuition down to in state levels. A difference of $16k per year over out of state tuition. Not chump change over 4 years. With the scholarship, she had enough to fully pay for her 4 year Engineering degree. I'll make the last payment here in December. Closing her 529 out.

Schools can be creative, but it does require checking on potential scholarships and related.

As a freshman, KU won the men's basketball national championship. What an experience for the students and fans. Kid 3 also plans to attend KU and knows it will rely on her keeping her GPA near 4.0.

 

[tulak]

1. Daughter keeps declaring she does not want to go to school in our home state. I'm working on a regular basis to convince her of the financial implications of out of state tuition. She is normally reasonable but still young and learning.

This is a tough one. We told our kids that anything over they would have to figure it out, even though we were willing to pay more (if it made sense), but we wanted to know how serious our kids were. In the back of my mind, I was thinking that they could borrow the money and when they graduated, we'd pay off the loan for them.

DS faced this choice and didn't apply to a school because it would have cost him $10k/year more, $40k total. He was choosing a lucrative major, so I told him that he should consider getting a student loan for the $40k, which he could easily pay-off. But he chose a cheaper university and it worked out well for him, even though there's the occasional what-ifs. I doubt he would choose differently if he had to choose again.

 

[all4j]

This leaves a gap of $40K I need to cover over four years. I'm set to have this covered with contributions alone and no growth.

I completely understand the philosophy of going all cash; especially if you are set to handle with no growth. But, there is also risk there imho. All of this is based on assumptions of course so it can be argued at length. My bet is that your projections for college that far out may be incorrect. Broadly speaking, college costs have exceeded broader inflation (& certainly more than cash). However, in certain instances, it has actually gone down. So, gauging what tax law will be, what cash will return, etc leaves the target a bit too vague to me.

I don't know if you are getting a tax break on contributions. There will be expenses that aren't eligible for 529 funds. You may as well keep some out of 529 if you aren't sheltering growth. btw, I think we're all aware that I'm suggesting a riskier approach than some are comfortable with. ymmv

 

[SecondCor521]

One mistake I made with my 3 kids' 529 plans was not including the AOTC in my plans.

At the simplest level, it is better to pay the first $4K per kid per year for four years out of pocket and use the AOTC on that $4K, then use the 529 for the rest.

The consequence of that, though, is needing $4K per kid per year less in the 529s, which is $32K in the OP's situation with two kids. $32K is enough, IMHO, to reflect in the calculations, even though the OP's target is still fuzzy.

(There are lots of niggling details and further optimizations on the AOTC / 529 combination which I will leave as an exercise for the reader, mostly because my kids are all recently done with college so I'm forgetting all those things.)

 

[Flyfish1]

IMHO - if you need that money to pay for college it should be in a stable asset investment or money market during the college years. That is exactly what I did for my two kids during their college years, and what I just did again for my daughters grad school. Yes you may miss some growth, but you limit the risk and sleep well at night.

I made the change roughly a year before they started college. Then I reinvested any money leftover into the market, as luck would have it that was the spring of 2020, somewhere around May and the market was just moving up off the bottom crash.
Market timing....you're darned right it was.

 

[all4j]

(There are lots of niggling details and further optimizations on the AOTC / 529 combination which I will leave as an exercise for the reader, mostly because my kids are all recently done with college so I'm forgetting all those things.)

I agree it takes some planning. Compound that with likely tax changes between now & then -- I've no idea if aotc is on the table. It does appear to me that student loan forgiveness may be less in the future rather than more. I'm not smart enough to predict the impact that may have on costs. Will it reduce # of students? No impact? Your guess likely better than mine!

 

[HarveyS]

I'd leave the money invested in equities. I did that with my kids and it worked out fine. Kids were in college from 2016 - now. I have about 4 more years of college bills, and I am staying fully invested in equities. YMMV

 

[FlaGator]

I'd leave the money invested in equities. I did that with my kids and it worked out fine. Kids were in college from 2016 - now. I have about 4 more years of college bills, and I am staying fully invested in equities. YMMV

Which proves everyone has a different risk tolerance when it comes to paying for college.

I invested those funds aggressively when they were young, but less so as they approached the time to need the money. My approach then switched to conservative - lock it in, one less thing to worry about. Worked out for me, and I was past the point of being able to comfortably pay the excess out of pocket.

Everyone's situation is different.

 

[SnowballCamper]

FWIW on DD's coverdell a while back I shifted from 100% stock index fund to about a third in BND. Then interest rates rose (and BND wend down). I have since been running a treasury ladder. I imagine there is a target date option in the 529 that would be prudent. Or just roll the dice on the future stock market. Maybe let the kid decide...

 

[youbet]

I'd leave the money invested in equities. I did that with my kids and it worked out fine. Kids were in college from 2016 - now. I have about 4 more years of college bills, and I am staying fully invested in equities. YMMV

I'm putting three grand-youngin's through whatever post secondary education they want, wherever they want. (DW says she'll never let me take part in a "college financing planning session" with DS and DIL again where cocktails are involved ) I started ESA's first and then 529b's for each grandkid very early. Because of the early start and high equity AA's, the bulk of the accounts are CG's and reinvested divies.

The first is just finishing her engineering MS at an out of state public university, has accepted a job offer at a Chicago engineering firm and is almost off the Papa Payroll. #2 just started his freshman year at our in state university with a stem major. #3 is TBD.

Because of the magnitude and open-endedness of my commitment, I started with very aggressive AA's and stuck with them generally only going to cash one year, sometimes less, ahead of need. So far, the strategy has worked. But, I'm hesitant to recommend that path to OP and would be more inclined to recommend switching to a fixed income ladder for funds needed within five years.

 

[surprising]

This is a tough one. We told our kids that anything over they would have to figure it out, even though we were willing to pay more (if it made sense), but we wanted to know how serious our kids were. In the back of my mind, I was thinking that they could borrow the money and when they graduated, we'd pay off the loan for them.

DS faced this choice and didn't apply to a school because it would have cost him $10k/year more, $40k total. He was choosing a lucrative major, so I told him that he should consider getting a student loan for the $40k, which he could easily pay-off. But he chose a cheaper university and it worked out well for him, even though there's the occasional what-ifs. I doubt he would choose differently if he had to choose again.

This was the philosophy we used for our daughter who just graduated. She had a certain amount in 529 and if she ran out she would have to figure it out. She chose an out of state college so it was really expensive. She had various jobs from freshman year on, paid for her own room and board every year, but still ran out of 529 money and had to get a private loan for the final couple quarters. She has since mentioned that she struggled a bit with college work because she had to work so much, but she also said it gave her a lot of pride that she was able to do it. In retrospect though, I feel bad that she was struggling and that it took away from her college experience. I think I shouldn't have been so black and white about the financing and perhaps provided more if possible. Since the market and my net worth have leaped over the time she was in college, I easily could have provided more. So I think there is a good balance somewhere and it shouldn't be so draconian.

 

[surprising]

Which proves everyone has a different risk tolerance when it comes to paying for college.

I invested those funds aggressively when they were young, but less so as they approached the time to need the money. My approach then switched to conservative - lock it in, one less thing to worry about. Worked out for me, and I was past the point of being able to comfortably pay the excess out of pocket.

Everyone's situation is different.

I put both of my kids 529 in the high school graduation date fund which gradually went from aggressive when they were in single digit age to basically money market/short term bonds at graduation date. The timing couldn't have been worse. My oldest daughter graduated high school in 2020 and the fund switched to mostly money market/short term bonds right at the bottom of the covid selloff. So she locked in losses there. Then the market went gang busters for the next 4 years and she didn't participate much in that gain. Also the first couple years the fed rate was 0 so all of her bond funds were paying very little. Then in 22 fed funds rate exploded, causing her to lose some money in those 'safe' bond funds.

My second daughter graduated in 2022 and had similar problems where the fund went to all money market/short term bonds when fed funds were at 0%, and then fed funds rate exploded and so she lost money in those 'safe' bond funds.

I'm not advocating any kind of strategy, just saying that even with the best of intentions, things can go to ****.