Pedal to the metal: Why 529 plans demand aggression

A section 529 plan can be a useful education savings vehicle, but to get the most out of them, you have to be aggressive. This applies to both how you fund them and how you invest them.

Why the pedal-to-the-metal approach for 529 plans? Because you are chasing a fast-moving target. Over each of the past three decades, college tuition has grown at a significantly faster rate than inflation. With savings accounts and other conservative investments not even keeping up with inflation, investing an education fund that way means you are guaranteed to fall behind. Stocks at least have a chance of keeping up with -- or even exceeding -- the pace of increase in education costs.

The tax benefit of 529 plans is another reason for investing aggressively. Contributions to these plans are not tax-deductible, but earnings on their investments are tax-free as long as the money is ultimately used for education. With interest rates on savings accounts, money market accounts and most other deposits below 1 percent, the tax advantage of a 529 plan would be negligible. Investments with a higher return potential increase the potential tax benefit.

Of course, stocks are far from a sure thing, which is why you need to be aggressive in funding a 529 plan. That means starting early and making regular contributions. Getting an early start will allow you more time for the fluctuations in stock prices to work themselves out in your favor. Making regular contributions means you will be practicing dollar-cost averaging -- by continuing to invest when stocks are down, you rebound more strongly when stocks recover.

Tips for making a 529 plan work

Based on the above principles, here are four tips for making a 529 plan work.
  1. Start early. College is expensive. The more years you can spread that expense over, the easier the burden will seem. This also gives your investments more time to help lighten that burden.
  2. Make contributions a monthly budget item. If your children's education is a priority to you, then make it a budget priority. Sacrificing some spending money every month will sting a little, but not as much as writing huge checks when your kids reach college age.
  3. Encourage family to direct gifts to the education fund. Especially in large families, kids are often overwhelmed at birthdays and holidays by more gifts than they can handle. Certainly, fun and games have their place in raising children alongside dollars and cents, but encourage family members to balance the toys with gifts to the education fund.
  4. Feature stocks at first, then start to scale back. Go for growth in the early years, then increasingly shift to savings accounts or similarly conservative -- and liquid -- vehicles as the time to use the money approaches.

Remember: The return on 529 investments is not measured simply by what they earn in the plan. The real payback comes from brightening a child's future.