Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Eats Your College Savings Plan
Transcript
- Lucas: So Luna, we talk a lot about how inflation quietly eats away at things like your emergency fund or your bond ladder. But there's one big-ticket item that families are saving for years in advance, and I think we've never actually tackled it on this show. Luna: Let me guess — college? Because that one keeps me up at night, and I don't even have kids yet. Lucas: Exactly. College tuition has been outpacing the general inflation rate for decades. Historically, the cost of a four-year degree has risen two to three percentage points above CPI. So if you're putting money in a 529 plan, you're not just fighting the inflation you see at the grocery store — you're fighting a much faster-moving beast. Luna: And the CPI numbers we just saw? July's headline was up a whisker, but that's the broad index. Tuition inflation is a different animal. Lucas: Right. The broad CPI is running at maybe two and a half percent. But college costs have been climbing at four to five percent, sometimes more. Over eighteen years, that difference compounds dramatically. A hundred dollars saved today needs to grow at that higher rate just to keep pace with the actual cost of a degree. Luna: So what's the typical parent supposed to do? I mean, the default advice is usually 'just open a 529 and pick a target-date fund.' Is that enough? Lucas: It's a start, but here's the thing: most target-date funds for college are built with a glide path that assumes you'll need the money by the time your kid hits eighteen. They get increasingly conservative. But if tuition inflation runs higher than expected, that conservative allocation might not keep up. You could end up with a nice, safe portfolio that simply doesn't buy what it used to. Luna: So you're saying the all-in-one solution isn't so all-in-one when inflation runs hot. Lucas: Exactly. And look, I'm not saying target-date funds are bad. They're a great default for a lot of people because they force discipline. But if you're ten or fifteen years out, you might need to take on a bit more equity risk than the typical glide path offers, or you might need to save more each month to compensate for the inflation gap. Luna: And what about those prepaid tuition plans? Some states offer them where you lock in today's tuition rates. Lucas: That's a great point. Prepaid plans are essentially a hedge against tuition inflation. You're buying credits at today's price for a future education. But they have their own risks — they're usually tied to a specific state's university system, and if your kid decides to go out of state, the value conversion might not be dollar for dollar. Also, the plans are often underfunded, so there's a risk the state could change the terms down the road. Luna: So it's not a perfect solution, but it does solve the inflation problem for that specific cost. Lucas: Right. And it's worth noting that these plans have been getting more popular again as tuition inflation stays stubbornly high. But you have to read the fine print. Luna: Now, there was that recent rule change about 529 plans being able to roll over into a Roth IRA. How does that factor in? Because that seems like a big deal for people worried about over-saving. Lucas: That was a game-changer. Starting in 2024, you can roll over up to thirty-five thousand dollars from a 529 into the beneficiary's Roth IRA, as long as the account's been open for at least fifteen years. So if your kid doesn't use all the money for school, or you just want to give them a head start on retirement, that excess can go to work tax-free in a Roth. That's a massive incentive to maybe over-save a little, because the downside is no longer as painful. Luna: That's a nice safety valve. But is there a catch? There's always a catch. Lucas: There is. The rollover is subject to the annual Roth contribution limit, so it's not like you can dump the whole thirty-five thousand in one shot. And the beneficiary has to have earned income to contribute to a Roth. But for a kid who graduates and gets a job, that's a pretty sweet deal. Luna: So, let's talk about the current market environment. We've got gold up almost five percent in the last week, and the S&P 500 down about a percent. How does that affect someone saving for college? Lucas: Well, that flight to gold tells you there's some nervousness out there. And a down week for stocks can be scary if your kid is about to start school. But for a long-term saver, a few percent swings in the market are just noise. The real enemy is the steady, compounding inflation in tuition costs. Luna: So you're saying don't panic sell your 529 when the market dips. Lucas: Exactly. That's the worst thing you can do, especially if you're years away. But it does highlight why you need to match your investment horizon. If your kid is five years from college, you should probably be shifting to bonds and cash equivalents, even if that means accepting lower returns. The goal is to protect what you've saved, not to chase growth. Luna: And with the Fed funds rate sitting at three point six three percent, high-yield savings accounts and short-term Treasuries are actually paying something. So parking money for the short term isn't as painful as it used to be. Lucas: That's a key point. You can now get a decent yield on cash, so the opportunity cost of de-risking isn't as high as it was a few years ago. That's a different backdrop than when rates were near zero. Luna: So, what's the one takeaway you want listeners to remember about protecting their college savings from inflation? Lucas: I'd say it's this: don't assume that a generic target-date fund is automatically inflation-proof. You need to look at the actual expected cost of college, estimate your shortfall, and save accordingly. And don't be afraid to use tools like prepaid plans or even a small allocation to inflation-protected securities like TIPS to hedge against tuition inflation specifically. Luna: That's solid. And for anyone listening who's been meaning to map out a college savings plan, this might be the nudge you need. Lucas: Honestly, if today's conversation helped you think about your college savings strategy a little differently, that's the kind of thing we love to hear about. And if you ever feel like supporting the show, there's a way to do that without any pressure — it's buy me a coffee dot com slash fexingo. Every little bit helps us keep the podcast ad-free and focused on the topics that matter to you. Luna: Yeah, we're not going to guilt you into it. But if you found this helpful and want to keep us going, that link's there. No strings attached. Lucas: So, back to the practical side. One thing we haven't mentioned is the impact of fees on 529 plans. Not all plans are created equal, and high administrative fees can eat into your returns just like inflation does. Luna: Good point. How much of a difference can fees make over eighteen years? Lucas: Let's say you're investing ten thousand dollars and the plan charges one percent in fees versus a low-cost option charging zero point one five percent. Over eighteen years, assuming a six percent annual return, that one percent fee could cost you nearly three thousand dollars more in lost growth. That's a meaningful chunk of change that could have gone toward textbooks or tuition. Luna: That's a big deal. So it's worth shopping around for a low-fee 529 plan, even if it's not in your home state. Lucas: Exactly. Many states offer tax deductions for contributions to your own state's plan, so you have to weigh that against the fee difference. But some states have fantastic low-cost plans, and you're not locked in to your home state's plan if it's expensive. Luna: And with the dollar limits on contributions, is there anything to keep in mind for high earners? Lucas: The annual gift tax exclusion is eighteen thousand dollars per donor per beneficiary in twenty twenty-six. But you can front-load five years' worth of contributions in a single year — up to ninety thousand dollars per donor — if you treat it as a five-year gift. That's a way to get a large sum into a 529 early and let it compound tax-free. Luna: That's a smart move for grandparents too, right? They can help without triggering gift tax. Lucas: Absolutely. Grandparents can open their own 529 for a grandchild and even take advantage of the Roth rollover themselves if the rules apply. It's a flexible tool. Luna: So, as we wrap up, what's the one action step you'd give to someone who's just starting to save for college? Lucas: Start now, even if it's small. The power of compounding is your best ally against tuition inflation. And don't try to time the market — just set up automatic contributions, pick a low-cost plan, and review your allocation at least once a year to make sure it still matches your risk tolerance as the college start date gets closer. Luna: That's the kind of advice we can all use. Thanks for breaking it down, Lucas. Lucas: Anytime, Luna. And remember, the best time to plant a tree was twenty years ago. The second best time is today — same goes for a 529 plan.