Should You Be Worried About Your 529 Plan in 2022?

Key Takeaways

• We saw bonds sink along with equities this year. So, 529 portfolios have not done well.
• 529 plans offer target-enrollment or age-based options that have an aggressive, a moderate, and a conservative track. The aggressive track will have an above-average equity allocation, while the conservative one will have below-average equity allocation.
• Once you've dedicated assets to a 529 plan, you can switch to another plan. This is called a rollover.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. 529 education savings plans have become a popular vehicle for saving for college. But with both stocks and bonds in the red in 2022, some plans have posted losses that might surprise investors. Joining me today to discuss the performance of 529 plans in 2022 is Patty Oey. Patty is a senior analyst with Morningstar Research Services and leads Morningstar's 529 plan research.

Hi, Patty. Nice to see you today.

Patricia Oey: Hi, Susan. Good to see you.

Dziubinski: Let's start out with a bird's eye view of 529 plan performance in 2022. In general, how do things look?

Oey: Yes, they don't look so great. As you mentioned, equities and bonds are down about the high teens. You usually have equities to provide that upswing, and usually, you hope that the bonds will serve as a ballast, which they haven't. I mean, it was a perfect storm at the beginning of the year. Yields are really low. The Fed had to get aggressive about fighting inflation. So, we saw bonds sink along with equities this year. So, portfolios like the 529 portfolios have not done well.

Dziubinski: Let's get a little bit more granular and maybe review some of the performance based on target date and how things look through that lens.

Oey: Right. So, most investors, they invest in the series, as you mentioned, a target date. You pick the portfolio based on your child's age, and then over time as the child gets older, the portfolio generally derisks. Say, you have a child who is going to go to college in about 15 years, that child is very young, the portfolio would probably have about a 90% allocation in equities. So, that portfolio did quite poorly. Not surprisingly, it's mostly equities. It's down close to 20%. If you have a child who is about 15 years old, maybe the equity allocation is more around 30%. So, that did a little better. But of course, because bonds did poorly, those were down maybe about 13% as well.

Dziubinski: Let's talk about which plans have really underperformed and why.

Oey: Maybe the simple way to answer this question is that a number of plans, they will offer these kind of target-enrollment or age-based options, and they will offer an aggressive, a moderate, and a conservative track. The aggressive will have above-average equity allocation. The conservative will have below-average equity allocation. And so, yes, the aggressive portfolios tend to do poorly because of the market environment. But of course, on the flip side, when markets are rallying, those performers tend to do better.

Dziubinski: Then, conversely, have there been, sort of, standouts that we've seen in 2022 that maybe have held up reasonably well, relatively speaking?

Oey: When you ask that question, I think it's important to look at the portfolios that are for people who are just about to go to college or who are in college. So, the idea is that if you have still a reasonably long investment horizon and if the child is still young, these declines that you've just seen, hopefully, you can recover over time. But if your child is 18 or 19, in college, to take such a large hit that we've seen in the markets is really difficult. So, for those portfolios, we do want to see some defensiveness. Typically, most plans keep about 10% in equities because we feel like it's important to have a little upside because college costs are always going up. But we want the bond sleeve to be more defensive. And as we've seen, investment-grade bonds did very poorly. So, we would like to see very short-duration bonds or money market or something cashlike as an allocation in those portfolios. So, portfolios with a bonds sleeve that's well diversified with very, very short duration instruments, those have done better. And then, the ones that only had investment-grade bonds, those did poor.

Dziubinski: Let's say an investor is looking at his or her 529 plan for their children, and they're saying, you know, I'm dissatisfied with this. It just isn't really stacking up with maybe these other ones. Once you've dedicated assets to a 529 plan, can you switch to another plan, and if yes, what's that process like?

Oey: Yes, you definitely can. It's called a rollover. I mean, we have this with our retirement funds as well. So, you can roll over into another plan. I would say maybe the first thing you should consider is that if you are invested in your state's plan, some states offer an income tax benefit if you invest in their plans. So, if you're already in that plan and you're getting a tax benefit, you want to weigh that as part of your decision-making, I would say, generally, you may want to consider changing plans if it's a very pricey plan. Otherwise, if your plan is relatively cheap and maybe you're concerned that maybe the portfolio is too aggressive or too conservative for you, what you can do is that, say your child is 10 and the portfolio currently maybe has an equity allocation of about 50% and you feel like that's too conservative, you want to be more aggressive, then maybe you can shift down and switch to a portfolio that's for a 4- or five-year-old that might have a higher equity allocation, and then you'd follow a slightly more aggressive track relative to where you should have been, and that's an option as well.

Dziubinski: And if you want to figure out how your plan stacks up, Morningstar does rate 529 plans. So, you can definitely check out those to make some comparisons as well. Thank you for your time today, Patty. We appreciate it.

Oey: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch "3 Stocks to Sell Before 2023" for more from Susan Dziubinski.