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Last year, with markets going nuts and inflation still roaring, as soon as I would put money away for college, it seemed to lose value immediately.
My kids are still in high school, and the one thing I know for sure is that I shouldn’t cash out. Staying invested is the savvy choice for long-term goals, even just a few years. But in conditions like these, it’s can still feel just too hard to keep making new contributions into stocks.
I’m not the only one who sees it this way. One-time contributions to 529 plans dropped 20% in 2022, according to Ascensus, the largest administrator of 529 college savings plans in the U.S. That’s almost at the level of the 29% drop Ascensus saw in one-time contributions in 2008.
“People are nervous about putting money into the market, and also about inflation,” says Peg Creonte, president of government savings at Ascensus. “And people just have less money right now.”
The trouble with halting college savings is that it doesn’t stop time. High school graduation is coming. I have another year or so before my first tuition bill, and then six straight years of payments due for two overlapping kids. Ascensus found that those who set up automatic contributions kept them going through both the Great Recession and the current economic crisis and didn’t impede their progress.
I didn’t want to stop saving altogether. But what about diverting?
I made the move last year to put my ongoing college savings into Series I government savings bonds instead of continuing my automatic monthly 529 college savings account contributions.
This, technically, is still saving for college, it’s just not investing for college.
“Sometimes, we really need to pay attention to when that bill will come due,” says Beth Walker, a college advice specialist for Carson Wealth and author of “Never Pay Retail for College.”
If you were buying a house, she argues, you wouldn’t want to invest your down-payment money, you’d save it. In the same way, if you put a dollar of college savings in I-bonds, it won’t ever lose value or go backward. Investing has inherent risk, on the other hand.
How I-bonds can double as college funds
The chief benefits of 529 college savings plans are that they are separate investment accounts where the growth is tax-free if you use the funds for qualified education purposes. Many states give additional tax breaks for contributions yearly.
If you save regularly and diligently, you can grow quite a nest egg over the years, even if perhaps not enough for the whole bill given tuition rates of $80,000-plus for private universities. As financial pros always say, every dollar saved is one you don’t have to borrow.
Similarly, I-bonds are separate accounts where the funds can be used tax-free to pay for tuition (with some income restrictions), which is a much narrower use than what the IRS allows for 529s. But there’s a loophole: A parent can do a direct rollover from I-bonds to a 529 college plan and then the funds can be used tax-free for much more, like room and board, books, travel and to repay college loans, and with no income caps. You may even be able to get a state tax break when you do the rollover, if it’s available to you.
“I love the idea of having I-bonds that get rolled into 529s once there’s a market recovery,” says Walker. “Why not? You do an I-bond now, where you have some predictability, as savings. Then move it to 529 when they’re going to school.”
Note: You can’t hold I-bonds within a 529 account because you can only buy them directly through Treasury.gov.
How to make the switch
The first hitch I faced when moving to I-bonds is that I had saved so diligently for college for so long in my 529 that I didn’t know how to stop. I had to dig through the website of my state plan to figure out how to turn off my connected bank account, which I had set up some time around 2007 and hadn’t touched since.
Then I had to buy I-bonds, which to be honest, was no easier technologically, since Treasury.gov is wonky. I made note of the annual buying limit, which is $10,000 per individual per year, whereas the limit for 529 savings is tied to the IRS yearly gift tax limit of $17,000 currently and can be bunched to $85,000 – but neither cap was in my sights anyway.
To move I-bonds to a 529 account, you need a specific tax form (Form 8815), which is not intuitively written for that purpose, so you might need some help from a tax preparer or financial adviser. But it’s no harder than any of the other paperwork involved in spending college savings – withdrawing funds from 529 plans trips up many families also.
The long-term math
Since I’m close to the finish line of saving for college, my diversion plan is pretty low-risk. My 529 account has averaged around 6% growth per year over the last 16 years, but the last two have been brutal and my account is still down over the last 12 months.
Walker says people in this position could just keep investing. Much to our economic detriment, “the one thing we never buy when it’s on sale is the market,” she says. But otherwise, families could start switching to fixed-income options within their 529 plans or to an age-weighted portfolios that gets more conservative as the child’s high school graduation approaches.
On the other hand, I-bonds are fairly predictable. The added benefit of these particular government instruments beyond safety of principal is that they are specially designed to protect against inflation.
Rates on I-bonds have skyrocketed since 2021 and have been beating not only other savings products, but also general stock market returns. I got in at an annualized rate of 7.12% and the current rate until the end of April is 6.89%.
You’re locked into I-bonds for one year, and you lose three months of interest if you cash out before five years, but that fits the time frame of my younger child going to college perfectly. The interest rate of I-bonds resets every six months, so the ratio in favor of I-bonds compared with the stock market is not guaranteed to continue. As soon as it stops being in my interest, I can get out, but for now, it’s working for me.
