The Best 529 Plan Age-Based Investment Option

Reader Vicki left this comment on my previous post 529 Plans: Age-Based Options Don’t Make Sense:

"I was just about to enroll in an age based plan here but pulled up your page before I signed on the dotted line. Help!! I just want this over with. I thought I had looked at all options and was satisfied with my decision until I read your article."

I can understand her frustration. With so many 529 plans and so many options within each plan, it’s hard to decide what to do.

I stand by my original conclusion in that post: most standard age-based options in 529 plans are too aggressive. In a follow-up post Asset Allocation for a 529 Plan, I proposed an allocation that starts with 50% in stocks and 50% in bonds and/or CDs at birth. The allocation to stocks then goes down by 10 percentage points every three years. By the time the child reaches age 15, the account will be 100% in CDs.

How do we put this plan into action? Is there a way to set it and forget it, as one would in a standard age-based option?

Yes, if you use the Customized Age-Based option in the Utah Educational Savings Plan (UESP). Here’s how I would set up the customized age-based option in Utah’s plan:

  0-3 4-6 7-9 10-12 13-15 16-18 19+
Vanguard Total Stock Market Index Fund 35% 28% 21% 14% 7% 0% 0%
Vanguard Total Int’l Stock Index Fund 15% 12% 9% 6% 3% 0% 0%
Vanguard Total Bond Market Index Fund 50% 60% 70% 80% 0% 0% 0%
Vanguard Short-Term Investment Grade 0% 0% 0% 0% 90% 100% 0%
FDIC Insured Savings 0% 0% 0% 0% 0% 0% 100%

This simple setup uses maximum three funds at any time. The stocks portion is split 70:30 between US and international. The bonds portion starts with intermediate-term bonds and then moves toward short-term bonds and FDIC insured savings.

Utah’s UESP is the only plan I know of that allows you to create your own age-based option. I heard about it from reader Mike. In other plans you have to either take an existing age-based option as-is or do your own mix and adjust the allocation yourself as time goes by.

You don’t have to live in Utah in order to use Utah’s plan. If you live in the following states you don’t get any extra state tax benefits for contributing to the 529 plan from your own state; therefore you can use a 529 plan from any state, including the good plan from Utah.

  • Alaska
  • Arizona
  • California
  • Delaware
  • Florida
  • Hawaii
  • Kansas
  • Kentucky
  • Maine
  • Massachusetts
  • Minnesota
  • Missouri
  • Nevada
  • New Hampshire
  • New Jersey
  • Pennsylvania
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

If you live in other states you do get an extra tax break one way or another from using your own state’s 529 plan. You should first consider using your own state’s 529 plan. If you still like using an age-based option and that plan offers several age-based options to choose from, pick the most conservative one. If the plan only offers one age-based option, it’s likely too aggressive; you will have to do your own mix and adjust it every few years yourself.

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Comments

  1. Mike says

    Glad to see you followed up. :) One comment .. a little sharp for transition in bonds. I use UESP but mix from bonds / ST bonds / savings a bit smoother, rather than put nearly all in ST inv grade (active management) in the years before college. ST inv grade dropped 10% in 2008 stock market crash.

    I would much rather prefer ST bond index option instead of ST inv grade. Maybe it will change by then anyways, as my kids are young enough. I might just mix FDIC with TBM to get the duration I need. Utah residents also have the Utah treasurer’s fund option with no expense ratio.

    What interest rate does the FDIC savings pay?

  2. Harry Sit says

    Mike – I agree with you. In the draft of this post I had used a blend of all three fixed income options at different percentages. Then I remembered this post from another Mike — Changing Bond Allocations — which said not to worry too much about the finer details. So I went for simplicity for people who want an age-based option for its simplicity.

    The FDIC insured savings in UESP pay 0.72% as of March 2012. Not as high as Alliant Credit Union at 1.0%, but still pretty good.

  3. Pennybags says

    Interesting, how would you implement this plan using the Ohio College Advantage direct plan? Is there any advantage to using TIPs in additon to the bond fund? Also, isn’t the 0-3 category a bit conservative with 15 years left until college?

  4. Vicki says

    Thank you for this article. It helps me a lot. It was the Utah plan I was thinking of going with so I at least feel good about that. :) I really try to take care of my finances and investments but the truth is, I am not educated about it all. I must admit Mike’s comment above worried me a little since I have no clue what you guys are talking about but I am going to go with your advice in the article and not worry about the finer details. One question though…my kids are 6 and 8 and I am only starting a plan for them now. Do I still use the same age based plan you detailed above? I was thinking to invest maybe $1500 to start and $500 per month each. Any more advice you can give? Thank you!

  5. Harry Sit says

    Vicky – Yes if you’d like to use the customized age-based setup I put together above. With Utah’s customized age-based option, you have to input the investment options and percentages for all age brackets, even if your kids are already older.

    “Allocations for the pre-set age brackets, even if the beneficiary is older than an age bracket, must be selected when the Customized Age-Based investment option is initially established.”

    Source: http://www.uesp.org/Investment-Info/Investment-Options/Customized-Age-Based.aspx

    If you are starting late, it only means that you have to save more for them, or accept that the 529 won’t cover 100% of what they need (they will cover the rest by jobs and loans). Taking more risk isn’t the answer.

  6. Vicki says

    Just saw that on their site. Thanks. I will add more to it in lump sums soon but I can’t wait any longer to start. Thanks for your help.

  7. Harry Sit says

    Pennybags – The Ohio CollegeAdvantage Direct plan doesn’t have a customized age-based option. You can use either the built-in “Vanguard Conservative Age-Based Option” or do your own mix and adjust the mix every few years yourself. I would suggest:

    Age 0-2:
    50% Vanguard Aggressive Growth Index Portfolio
    25% Vanguard Moderate Growth Index Portfolio
    25% Vanguard Inflation- Protected Bond Option

    Age 3-5:
    18% Vanguard Aggressive Growth Index Portfolio
    52% Vanguard Moderate Growth Index Portfolio
    30% Vanguard Inflation- Protected Bond Option

    Age 6-8:
    55% Vanguard Moderate Growth Index Portfolio
    10% Vanguard Conservative Growth Index Portfolio
    35% Vanguard Inflation- Protected Bond Option

    Age 9-11:
    20% Vanguard Moderate Growth Index Portfolio
    40% Vanguard Conservative Growth Index Portfolio
    40% Vanguard Inflation- Protected Bond Option

    Age 12-14:
    40% Vanguard Conservative Growth Index Portfolio
    17% Vanguard Income Portfolio
    43% Vanguard Inflation- Protected Bond Option

    Age 15+:
    25% 3-year CD
    25% 4-year CD
    25% 5-year CD
    25% 6-year CD

    I explained the reason for staying conservative in the previous post. For someone 50 years old saving for retirement at age 65, the rule of thumb is “age in bonds” i.e. 50% in stocks. But a retirement account has a much longer draw-down period than a 529 plan account. Therefore investing 50% in stocks at age 0-3 in a 529 plan isn’t too conservative.

  8. Erik says

    Vicky – I wanted to suggest this site I ran into (and used) recently – http://www.gradsave.com. I set up a profile (you’ll need a 529) and for my kid’s third birthday I asked friends to give me some money for college savings instead of other gifts. It was a little weird asking for that but in the end a few of my friends just gave me money online and they deposited it straight to my 529 plan so it was great to get a little extra in my kids 529 plan.

  9. Pennybags says

    Thanks for your response. This is really helpful information. I really like the idea of a CD ladder a few years out from college.

  10. John says

    You have given inaccurate info for PA residents. We get a tax benefit for contributing to ANY state’s 529 plan so PA residents should be on the list of states whose residents should feel free to invest in UESP’s fine program (I have).

  11. Harry Sit says

    John – Thank you for the note. It looks like several other states are also like Pennsylvania. There is a tax benefit but the same tax benefit is given regardless which state’s plan you use. I added Arizona, Kansas, Maine, Missouri, and Pennsylvania to the list where people can use the Utah plan.

  12. JJ says

    TFB, I’ve tried to goggle this but couldn’t find anything. I am just wondering if you or any of your readers might know the answer.

    I contributed to an Illinois 529 plan for my kid since 2007 in order to get tax deduction benefit.
    IL income tax rate used to be 3%, and they increased it in 2010 to 5%.

    Is it possible for me to withdraw my contribution portion that I contributed between year 2007-2009, re-deposit it for 2011-2013 contribution, and collect the 2% of the tax deduction benefit?

    Maximum allowed contribution/year is $10K, and usually I contribute between $4-5K/year.
    Is there any penalty to withdraw the contribution portion?

    Thanks.

  13. Harry Sit says

    JJ – Sorry your clever scheme won’t work. Unlike a Roth IRA from which you can withdraw the contributions first, a withdrawal from a 529 plan is proportional: part contributions, part earnings. When the withdrawal isn’t for qualified higher education expenses, you pay federal and state income tax plus a 10% penalty on the earnings portion. In addition, the state of Illinois will make the contributions portion taxable. This completely negates any deduction you will get when you re-contribute the money back into the plan. You are left with paying federal income tax and penalty on the earnings. See A Change (not for the better) For Illinois’ 529 Plans.

  14. JJ says

    TFB, thanks for your quick response. I didn’t realize that the 529 withdrawal is proportional. I thought it’s like Roth IRA. Thanks!

  15. Sam says

    TFB, Thank you for the great article. I am an Ohio resident about start 529 contributions. I like your detailed post (number Eight) about age based mix. What do you think about ‘Advantage Age-Based Option’ in Ohio 529 plan. Interestingly, it looks like it will pretty much converge with your mix around Age 12-14.

  16. Harry Sit says

    Sam – I don’t like the Advantage Age-Based Option in the Ohio 529 plan at all. Too aggressive. It does not converge with my mix in comment #8. My mix at age 12-14 has 40% in Vanguard Conservative Growth Index Portfolio, which itself invests 25% in stocks. It means only 10% of the money is in stocks (40% * 25%) whereas the Advantage Age-Based Option has 40% invested in stocks at age 13.

  17. Sam says

    TFB, thank you for the quick response and clarification. I completely missed underlying mix in ‘Vanguard Conservative Growth Index Portfolio’.

  18. Harry Sit says

    Bonafede – No, but I just did. Nebraska’s plan has four age-based options. The index option is still more aggressive than I’d like. The conservative option is pretty conservative. It uses a mix of index funds and actively managed funds. Expense isn’t the lowest but not too bad, only about 0.20% higher than the index option. Maybe 50/50 index and conservative age-based options?

  19. steph says

    HI there, I will start by saying I know pretty much nothing about finance, so a lot of this is Greek to me. I just need advice because I have a 9 year old and I don’t have a college savings plan yet. So with about 9-10 years left till college, what is my best option? I am a California resident, and also work for the State. What would you suggest I do, and which plan? OF course, low up front fees are important. I don’t have many thousands to start the account with. Single mom, you know. Thanks for any help. She will likely, hopefully, attend one of the UC schools, maybe UC Davis, where we live. Unless she gets the “i gotta move away from here!” bug. But I plan on encouraging her to stay within California due to out-of-state fees.

  20. Harry Sit says

    steph – Open a Utah 529 plan at http://www.uesp.org. Choose Customized Age-Based option. Enter the investment options and percentages as shown in the table in the article. Contribute the amount you feel comfortable with.

  21. HZ says

    Hi, TFB,

    I need your advice. I am a NJ resident and have 2 children so far, one 3.5 and one newborn. I want to start saving college for them. The first question I have is: which could be better, do my own investment and regularly put money in good mutual funds and keep monitoring them, or invest in a 529 plan? Is the tax advantage of 529 plan greater enough to not to do the investment by myself? What kind of return rate and expense of a 529 plan is considered better than the conventional investment? The second question is which 529 plan would be good for NJ residents, in terms of return, expense, and tax? Thank you very much.

    HZ

  22. steph says

    Thank you TFB! WOndering…..we in CA have “scholarshare.” Are there more benefits to using that plan since i’m a resident, rather than using the Utah plan? Another blog rated Scholarshare on his “honor roll” even though UESP is on the short “High Honors” list. But he said to go with your own state’s plan if it made it to the honor roll for state tax benefits and/or lower fees as a resident. what is your opinion of that?

  23. steph says

    Update….i used a college savings plan compare program to compare utah’s and scholarshare….gosh it doesn’t really seem like i get an advantages to using the CA plan as a resident. No tax advantages that I can see. Utah’s still looks better….do you concur?

  24. Harry Sit says

    @HZ – If you’d like to manage the investments on your own as opposed to doing an auto-pilot, you can still do it in a 529 plan. As in a 401k plan, your options are limited to what the plan offers but I think there are enough options to play with. There is a one change a year limit. I think the tax benefit beats the limit in investment options. NJ is one of the 21 states (see list in the article) that don’t give any special treatment to its own 529 plan. So you can choose any plan. Utah UESP is a good one. Ohio’s CollegeAdvantage Direct is another good one.

    @steph – California is also one of the 21 states that don’t give any special treatment to its own 529 plan. You can choose any plan. California’s ScholarShare isn’t bad, but I think Utah’s and Ohio’s are better.

  25. steph says

    well the low startup is key. I don’t even have a thousand to start with so utah’s plan seems like a no-brainer.

    many thanks! i’m going to pass your blog and this info along to all my facebook peeps.

  26. Al says

    I just wanted to double check what you said to Steph – I saw the same article that said if you are in California to go with the ScholarShare. On the ScholarShare website, it says that with the plan, contributions and any earnings are federal and California income tax-free but I do now that there are no tax deductions unlike pretty much every other state. Is this benefit of no federal and california income tax worth staying in California or is the Utah plan far superior? I find it very difficult to get my head around all of this!!

  27. Harry says

    @Al – Contributions to and earnings in all other 529 plans are also federal and California income tax-free. ScholarShare isn’t bad. It just doesn’t have anything special to California residents. You are free to choose other plans.

  28. Rolando says

    Mr. Sit, why just the five funds listed in the article, why not use the same recommended percentages but spread them across the fund families offered; if more than one exists? For example, for the age group 4-6, why not put 7% in each of the four U.S. Stock funds (VITPX, VIIIX, VMCPX, VSCPX), 6% in each of the two International funds (VTPSX, VIDMX), and 30% in each of the two Bond funds (VBMPX, VFSIX? Thanks for your assistance.

  29. Harry says

    Rolando – The three Total funds already include everything as a package (hence ‘Total’). Spreading further among constituents doesn’t add anything. Example: a McDonald’s meal includes a burger, fries, and a drink. You wouldn’t order a meal plus another burger, another order of fries and another drink. You might as well just get two meals.

  30. Kristyn says

    Thank you for this post! Another IL resident here except I’m looking to open a 529 for my 8 month old. I’m trying to decide between using Utah’s 529 custom age-based plan you recommended or using IL’s Bright Directions 529 plan to get our up to 20K married deduction. (I figure we’ll be saving 4K per year so by the time our child turns 18 that deduction will save have saved us $3,600 at the current 5% IL tax rate which will help.)

    The most conservative age-based Balanced Option Bright Directions offers has 60% stocks and 40% bonds initially. Then at age 9, the portfolio begins to shift and is invested in 40% stocks and 60% bonds. As the beneficiary nears college age, the portfolio is invested in 10% stocks, 50% bonds, and 40% cash equivalents. But that still seems pretty aggressive to me.

    IL does offer Vanguard funds which I like and I have the option to pick individual portfolios, but Bright Directions doesn’t have all the ones you recommend here. The IL Vanguard options can be found here: http://www.brightdirections.com/individual.asp?PgID=3&SmID=33

    I was thinking of selecting the following individual Vanguard portfolios based on their performance:
    Equity- Vanguard Mid-Cap ETF 529 Portfolio and Vanguard FTSE Emerging Markets ETF 529 Portfolio
    Fixed Income- Vanguard Short-Term Bond ETF 529 Portfolio and Vanguard Total Bond Market ETF 529 Portfolio

    How would you allocate a conservative age-based plan using IL’s options? (I have no problems adjusting the percentages myself every couple years.) I can mirror your example up to a point, but I’m not sure what to do when our kid gets older since Bright Directions has no FDIC insured savings or CD’s available. Do you think it would be best to use Utah’s plan instead for that added security when our child nears college age?

    I really appreciate the help!

  31. Harry says

    Kristyn – You want the Illinois Bright Start plan, not Bright Directions. Bright Directions requires an investment advisor. If you have an investment advisor, you wouldn’t ask a stranger on the Internet what to do. Bright Start has some index funds. As usual, the age-based portfolios are pretty aggressive, but you can use the Equity and Fixed Income index portfolios to create a blend. Age 0-3 50% Equity 50% Fixed Income etc.

  32. John says

    A Texas Resident, I decided to open up a Utah 529 plan for my 2 year old daughter. My daughter already had a savings account since birth and we decided to invest in a College Fund. I am no sure what to expect, but I invested in the 0-3 Age-Based Portfolio. I have only seen a $6.00 return over the course of about 4 months. Am I doing something wrong or should I invest in a more aggressive manner?

    Any help will be GREATLY APPRECIATED!!!!!! I am completely NOVICE when it comes to 529 Plans.

    I started the plan off with $3k and contribute 200.00 a month.

  33. Josh says

    TFB – Thanks for all the help, just opened up my custom Utah 529 – Is there anything you might currently add to your strategy since you posted this last. Thanks very much!

  34. Vicki says

    @John–
    I wondered which of the Utah 0-3 plans you chose–
    there are several which vary the stock/bond mix…
    we are opening a Utah plan for our 2 yr old grandson…
    some of the options have limited history on the Utah site–since the inception date is fairly recent…

    And in light of the past years of low bond yields, are people still thinking it makes long-term sense to have more than 30% of fund in bonds???

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