More safety features> could be on the way for 529 college savings plans.
On April 20, the House of Representatives passed the Deposit Restricted Qualified Tuition Programs Act of 2009, which would allow families to invest money for college in an account that's within a 529 plan but also insured by the Federal Deposit Insurance Corporation (FDIC). In most cases, this account would be a certificate of deposit (CD) or a savings account. The Senate got the bill on April 22 and referred it to the Senate Committee on Banking, Housing, and Urban Affairs. The legislation is intended to provide more investment options within college-savings plans, particularly for parents with low risk tolerance who were scared off by the double-digit losses many 529 plans experienced during the height of the recession.
Currently, seven states -- Arizona, Colorado, Montana, Ohio, Utah, Virginia and Wisconsin --offer savings vehicles that are FDIC insured within their 529 plans. This month, North Carolina's 529 state plan introduced a deposit account, which is insured by the National Credit Union Administration (NCUA). (In addition to an FDIC-insured CD, Wisconsin s plan offers a CD insured by the NCUA.)
Should this legislation become law, it would likely trigger more states to start offering safe, low-risk savings options with their 529 plans, says Joan Marshall, chair of the College Savings Plans Network (CSPN), an association of states that administer 529 plans. In addition to being low risk, these savings vehicles allow for earnings to grow tax deferred; by contrast, earnings on a regular CD or savings account are taxed annually as income.
However, some say the legislation could end up helping banks more than families. Most states that currently offer FDIC options within their 529 plans have a partnership with at least one bank -- for example, Ohio's CollegeAdvantage plan works with Fifth Third Bank and Utah's Educational Savings Plan works with Zions First National Bank. As states add FDIC options to their 529 plans, more banks could jump in to compete to operate the FDIC-insured accounts. An increased bank presence among 529 plans could be an unintended consequence, says James Boyle, president of College Parents of America, an advocacy organization for parents of current and future college students. "One of the questions that has to be dealt with [the legislation] is that the 529 plan was born as a state product," but we could see regional banks registering in other states to start offering these savings products, Boyle says.
There s also a concern that this legislation could ultimately create a new type of 529 college savings plan where the plan includes only FDIC-insured investments and the 529 plan would be managed by banks only, says Mark Kantrowitz, publisher of FinAid.org and FastWeb.com. Essentially, this would be a new form of 529 plan that would compete with the current investment-based 529 plans for family college savings funds. A representative from Rep. Emanuel Cleaver s (D., Mo.) office, who sponsored the legislation, says she does not think this will be the case.
Despite more possible bank expansion into the sector, though, some say the legislation will help consumers because of the additional options it will offer aside from investments tied to equities or securities. "Lots of people who had 529 plans in place before the financial crisis saw their educational savings diminish significantly as a result of the crisis, since 529 plans are investments in mutual funds and the like," says a spokesperson for the American Bankers Association. "This bill would give consumers additional options when planning for and managing those savings."
Here are five tips for college savers considering investing in FDIC 529 options.
Check out existing state plans
Individuals who like the idea of stashing at least a portion of their college savings in an FDIC-insured 529 account don't need to wait for their state to add a CD or savings account option to its 529 plan. In most cases, you can invest in an FDIC-insured CD within a 529 plan in a state that currently offers these low-risk investments.
Before proceeding, find out about the tax implications of investing in another state's 529 plan. Some states offer tax deductions or credits to families that invest in the state's own 529 plan. "If you live in a state where the gains on a 529 plan are not protected for state tax purposes, that may be a reason to look [elsewhere]," says Boyle.
In general, FDIC insurance protects each accountholder for up to a total of $250,000 (in checking or savings accounts, CDs and money-market accounts) at each FDIC-backed bank through Dec. 31, 2013. After that, FDIC coverage is supposed to drop back down to the original amount of up to $100,000.
But the numbers aren't so clear-cut with 529 plans. In this case, for full coverage by the FDIC, individuals can't surpass a value of $250,000 of their investments in a 529 plan FDIC-insured account and the value of any other accounts they have at that same bank.
Prepare for low returns
Placing a significant portion -- or all -- of your child's college savings in FDIC-insured products can guarantee that you won't lose your principal, but be prepared for low returns.
In general, rates tend to be higher on CDs within 529 plans than those available independently at banks. For example, in Ohio's CollegeAdvantage plan, a standard five-to-seven-year CD has a 3.5% annual percentage yield, with a minimum required opening balance of $500. But at Fifth Third Bank, a five-to-seven-year CD currently has a maximum APY of 1.6%. And as with regular CDs, longer maturities typically result in a higher return. CD maturities within 529 plans can range from three months to 22 years, says a CSPN spokesperson.
Returns can look especially low when compared with the rate at which college tuition is rising. Tuition at public four-year in-state universities increased an average of 6.5% from 2008-09 to the current academic year, while tuition at public out-of-state universities increased by an average 6.2%, according to the College Board. Tuition at private universities spiked an average 4.4%. "They're trading return for safety," says CSPN's spokesperson. "And these products probably won't keep up with tuition."
Fees and penalties could kick in
In most cases, if an individual withdraws money from a CD in a 529 account, it will be subject to penalties that can include losing several months (often three months) of interest, or in some cases it could be one half of the interest for the unexpired term.
And by locking into a CD -- especially for the long term -- individuals could be giving up the opportunity to make more money in a different type of investment.
Going forward, if banks start competing to operate these FDIC-insured accounts, parents should make sure they won't be subject to any fees, says Kantrowitz.
Get the right asset allocation
Parents set on CDs or savings accounts should consider using them as a way to balance out aggressive stock investments within the 529 plan. That way, they have some safety in case the market tanks just before their child starts college.
For additional safety, consider an age-based asset-allocation fund that gets more conservative as college approaches. Before opting in, make sure this allocation will give you less than 20% exposure to equities or other riskier investments starting two years before your child's freshman year, says Kantrowitz. And check to see what those conservative investments will consist of -- ideally, they should be in bond funds, Treasurys and CDs or money-market accounts, he says.