529 saving plans: no longer cool?

Net inflows into 529 saving plans have slowed as the economy remains weak. Many parents are looking at alternatives to the 529 saving plans.

Dan Henry/Chattanooga Times Free Press/AP/File
Students carried belongings to dorms during freshman move-in day, Aug. 16, at the University of Tennessee at Chattanooga. As inflows slow to 529 saving plans, parents are weighing alternatives for saving for college.

This fall, the Haubners send two kids off to college – and won't go broke. To pay the freight, they will use funds from the two 529 college savings plans they'd created years ago, as well as other savings and portions of their salaries.

But the biggest contributor? "Apple," says Patricia Haubner, a publicist, who lives with her husband in Westchester County, N.Y. Years ago, they'd bought a small amount of the stock for their kids, watched it zoom up in price, and are now tapping some of those gains.

Even as many experts tout 529 savings plans as the best way to save for college, interest in them is cooling. Net inflows into the state-administered plans have slowed. Some parents have diverted resources to pay down debt. Others are gravitating toward other tools to save for tuition bills. With the costs of college sky-high and growing, 529 plans remain a great way to invest for a college education. But they're not the only game in town, and it makes sense to look at alternatives.

Brian Solik switched. The former stockbroker, a father of five in Toms River, N.J., stopped funding the three 529 plans he'd set up for his oldest kids in 2008 when the plans suffered large losses in the stock market's crash. Now, as an independent financial adviser and founder of Wealth Preservation Strategies, he prefers using the cash value of life insurance policies for college savings – a strategy he learned about after leaving the brokerage industry.

A big reason for the switch? Some life policies allow quite conservative investments, he says. "Since my oldest child will be going to college in four years, I don't want to incur any more investment losses to our family's college savings."

Assets in 529 college savings plans (which differ from 529 prepaid tuition plans) fell from a record high in the first quarter to $157.5 billion in the second quarter – a 0.5 percent decrease, according to Financial Research Corp. (FRC) in Boston. In the third quarter of 2011, net inflows were negative – more funds flowed out than flowed in – the first time that happened since the middle of the Great Recession. In the first half of this year, net inflows were nearly 7 percent below the same period last year and about 60 percent below The second quarter's $2.9 billion in net inflows (contributions minus withdrawals) were 12 percent lower than they were a year earlier, and down nearly half from their prerecession heyday in the mid-2000s.

And a smaller share of families is relying on 529s. During the 2011-12 academic year, 11 percent of families used a 529 savings plan to save for college, according to Sallie Mae, a financial services company specializing in education and based in Newark, Del. That compares with 14 percent a year earlier and 15 percent the year before – and matches the 11 percent of families who used them in the 2009 recession year.

Many experts blame the slowing growth on pocketbook concerns. "The broader economy is impacting the average family's willingness to make contributions," says Paul Curley, FRC's college savings and research director. He points to "high unemployment, uncertainty in Europe, and the fact that families are saving less for college as they deleverage" by paying pay down debt.

Some parents and financial ad-visers opt for other college savings instruments, such as the Coverdell Education Savings Accounts, life insurance, accounts under the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act, and 529 prepaid tuition plans, among others.

Of his two favored college investing strategies – 529 plans and Roth IRAs – financial adviser Jim Martin prefers Roth IRAs. "Users of Roth IRAs aren't limited to the investment options in a particular state's 529 plan and can choose the investments they want," says Mr. Martin, owner of New River Financial Group in Radford, Va. Thus, if a Roth IRA holds the right investments, "it has the potential to outperform a 529 plan."

Returns haven't been great for most investments lately. For the five years ended in June, returns of 529 plans rose an average annualized 0.8 percent, according to FRC. The Standard & Poor's 500 stock index rose an annualized 0.2 percent over the same period.

The 529 plans retain distinct attractions – from tax advantages to a widening array of investment choices that include federally insured options. Fees are down. Parents generally can pick a plan offered by any state. Age-based portfolios, which invest more conservatively as a child nears college age, are especially popular.

Then there are the tax advantages. Monies in the accounts grow free of federal and state income tax; withdrawals are income tax-free on the federal level, and in most states, if the money is used for qualified college costs. Some states also offer a tax deduction or tax credit for contributions to the account.

That's why FRC forecasts that assets in 529 plans will start growing more robustly once the economy strengthens, rising some 80 percent by 2017.

"For most American families, 529 plans are the most powerful college savings vehicle out there," says Joseph Hurley, founder of Savingforcollege.com, a website for college financing advice.

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