How do 529 plan enrollment-based portfolio glide paths work?

Saving for your child or grandchild’s education needs is a great idea. But how should you invest, particularly given the relatively short window until the child is ready for college? 

Fortunately, certain target-date funds—specifically, 529 plan enrollment-based portfolios—make investing for an education easier than you might expect. In fact, these age-based portfolios are the asset management industry’s closest thing to a one-size-fits-all investment approach for school-bound savers and their families. And the glide path is the dynamic asset allocation trajectory that such funds follow to help investors pursue their education saving objectives.

The adoption of the target-date fund has been good news for retirement plan participants. They’re now likely to invest more easily and more appropriately—thanks to a single, yet powerful, step. What’s the simple step that replaced the formerly complex series of investment decisions? Choose the fund with a target date that most closely corresponds to the year you expect to retire.

While the role target-date funds play in retirement plans has become prominent since the Pension of Protection Act of 2006, the target-date fund remains one of the best-kept secrets in the world of education savings 529 plans, which are exempt from income tax under Section 529 of the tax code if the money is used for qualified education expenses. While the investment horizon may only span one or two decades, rather than six or seven, the basic concept is the same: Choose the fund with a target date that most closely corresponds to the year you expect to start paying tuition.

Perhaps the most distinguishing feature of any target-date fund—be it one geared for retirement saving or education savings—is its glide path design, representing the predetermined asset allocation adjustments to balance growth potential with risk management as the beneficiary ages. Enrollment-based portfolios typically keep the vast majority of assets invested in stocks during the early stages of the beneficiary’s life, when the first tuition payment is still years away.

What’s the rationale for this relatively high equity exposure? On average, stocks have historically generated higher investment returns than bonds over extended time periods, albeit with more risk.

The investment glide path for John Hancock Freedom 529 enrollment-based portfolios, for example, starts with virtually all of its exposure in equity investments, while the enrollment date remains a couple decades away. Over time, the glide path calls for shifting this allocation from stocks to bonds. Ultimately, as the matriculation date becomes imminent, the glide path levels out to a stable proportion of 80% bonds and 20% stocks. This residual stock exposure—even once the beneficiary has begun school—has tended to help portfolios keep up with tuition inflation. Over the past decade, tuition costs have risen more than 25%.¹    

The definition of tax-free qualified education expenses has been broadened in recent years. For college, qualified education expenses are typically defined as tuition and fees, room and board, and books and supplies. Student loan repayments of up to $10,000 per beneficiary as well as expenses for apprenticeship programs are also allowed. Additionally, 529 plans may distribute up to $10,000 per year for tuition expenses incurred during the taxable year in connection with enrollment at a public, private, or religious elementary or secondary school.³

Whether it’s for grade school, vocational school, undergraduate, or postgraduate study, the key to a successful education saving strategy is to start putting money aside early and to continue doing so regularly—and to make sure your portfolio maintains an age-appropriate asset allocation at each phase of the investment horizon. Enrollment-based target-date fund glide paths can help investors stay on track no matter what economic headlines the next news cycle may bring.