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College 529 plans offering the safety of CDs

Posted by Jill Boynton  November 16, 2009 10:03 AM

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It has been particularly unnerving for parents to watch their children's college savings accounts lose money during the current recession. Parents usually don't have as much time or ability to make up for these losses as they might their own retirement funds. So the reaction of many has been to run to safety by switching to conservative investment options. In an effort to address this several states have expanded their 529 plan options to include FDIC-insured accounts that invest in savings accounts or CDs. According to InvestmentNews Arizona, Ohio and Montana now offer FDIC-insured accounts. Are they a wise choice for you?

There is always a trade-off between risk and return in investing and, in general, the more risk you take the more you should be rewarded by earning a higher rate of return. So investing in guaranteed-rate CDs with very little risk means you will earn very little return - in the current market as little as 1 or 2 percent. With college inflation running 6 to 8 percent can you afford this trade-off? Perhaps, if your child is going to college in the next 1 to 3 years and you are more concerned with safety than return. But the more time you have the more you should be investing in equities. Equities can return 7 to 9 percent in the long run, which is 5 to 10 years. The allocation to equities depends on how old your child is, how much you have invested and how much you'll be adding to the account. A financial planner can help you figure out the right mix of stocks and bonds.

There is another difficulty with investing in CDs that is particular to 529 accounts. These accounts allow only one investment change in a 12 month period (with the calendar year 2009 as an exception, when 2 changes are allowed.) When a CD matures within the account your choice of how to reinvest the proceeds constitutes an investment change. Thus you are precluded from making any more changes to other investments in the account for the year. And this could also cause a problem if you have more than one CD in the account. Some plans are working on ways to automatically roll CDs into shorter-term investments as they mature, but it doesn't leave you the flexibility of making that decision yourself or choosing another investment option.

So even if you've lost some of the value of your 529 account, with interest rates so low it might not make sense to lock up your money in CDs.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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