Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Is Quietly Eating Your College Savings Plan
Transcript
- Lucas: If you have a 529 plan for your kid or grandkid, and you haven't looked at it since you set it up, I want you to do a quick mental exercise. The average private college tuition in the US has been rising at roughly three percent above the general inflation rate for the last two decades. And right now, with the CPI sitting at 332.6 as of June, we're still seeing core services inflation stickier than most forecasters predicted. Luna: So the money you're putting aside today — it's not just fighting general inflation, it's fighting tuition inflation on top of that. Lucas: Exactly. And that second layer is the one most people miss. A typical 529 plan invests in a target-date portfolio that shifts toward bonds as the child gets closer to college. But many of those bond allocations still hold nominal Treasuries — which means the real purchasing power of that money can get squeezed. Let's use a concrete example: say you have a newborn today and you want to cover four years at a private university. The current all-in cost — tuition, fees, room and board — is about sixty thousand dollars per year at the high end. In eighteen years, assuming three percent annual tuition inflation, that same year will cost roughly one hundred and two thousand dollars. Luna: That's nearly double. And your 529, if it's earning maybe six percent nominal, you're only beating tuition inflation by about three percentage points — but only if the portfolio doesn't have a bad sequence of returns right when you need the money. Lucas: That's the real risk. The thing is, many families don't think about sequence of returns risk in a 529. They assume that because the money is 'for college,' it will be there. But if the market drops when your kid is fifteen, and you're still heavily in equities, you may not have time to recover before the first tuition bill arrives. Luna: So what's the fix? I know some advisors have been pushing for a bigger allocation to TIPS or I-bonds inside the plan. But not all 529 plans offer those options. Lucas: That's the key point. Most state-sponsored 529 plans have a limited menu of investment options. A few — like Utah's my529 or New York's Direct Plan — offer an inflation-protected bond fund or a Treasury Inflation-Protected Securities fund. But many don't. So if you're in a plan that doesn't have a TIPS option, you might need to think about overfunding the account by ten to fifteen percent just to absorb the inflation hit, or consider using a separate I-bond account outside the 529 for a portion of the savings. Luna: And I-bonds are capped at ten thousand per year per person, so you'd need to start early if that's part of your strategy. Lucas: Right. And the current I-bond fixed rate is still attractive relative to history. But here's the thing: even if you do everything right on the investment side, there's another quiet eroder — the way the 529's 'qualified withdrawal' rules interact with inflation. If tuition goes up faster than your portfolio, you might end up with a shortfall, and then you're pulling from after-tax accounts. Or worse, you take a non-qualified withdrawal and pay a penalty. Luna: So the real question is: how do you model this? Most families just pick a target-date fund and forget about it. But maybe they should be doing a net present value calculation every couple of years. Lucas: Exactly. The net present value of your target college cost, discounted at your expected after-tax real return, tells you how much you need to have saved today. And if you rerun that every two years, you can adjust your contribution rate. It's not complicated — you can do it with a spreadsheet. But the planning assumption that tuition will rise at CPI plus three percent is actually more important than most of the market noise. Luna: And we just had Fed Chairman Kevin Warsh testify today about the path of interest rates. If he's signaling that rates will stay higher for longer because of sticky services inflation, that could affect the kind of bonds in your 529's glide path. Lucas: Absolutely. Higher rates mean lower bond prices in the short term, but they also mean higher yields on newly issued bonds. So a 529 with a longer-duration bond fund could take a hit if rates keep rising. But on the flip side, TIPS and I-bonds would adjust their principal with inflation, so they'd actually benefit from a higher inflation environment. The trick is matching the duration of your fixed-income holdings to your spending horizon, which is exactly when your kid starts college. Luna: Let's talk about what listeners can do today. If you have a 529, where should you look first? Lucas: First, check your plan's investment options. Look for a fund that explicitly says 'inflation-protected' or 'TIPS.' If it's not there, check the stable value fund — some of those have implicit inflation protection through crediting rates that reset periodically. Second, calculate your current balance against the net present value of your target. If you're short, increase your monthly contribution by as little as fifty dollars a month. Over eighteen years, that's about ten thousand dollars of extra contributions, which could cover a significant chunk of the inflation gap. Luna: And if you're just starting a 529 for a newborn, consider using a direct-sold plan with low fees and a TIPS option. The vanguard 529, for example, has an age-based option that includes a TIPS allocation in the later years. Lucas: Exactly. And speaking of planning, this is the kind of practical, numbers-driven conversation that we try to have on this show every week. And it's only possible because of listeners who support the show directly. If you've gotten something out of these episodes — maybe you've adjusted your emergency fund or reconsidered a bond allocation — a couple of dollars a month is genuinely what keeps these going. You can find us at buy me a coffee dot com slash fexingo. It's a small thing that makes a real difference in keeping the show ad-free and focused on the numbers that matter. Luna: Yeah, it really does. And we appreciate every bit of support, because it lets us dig into topics like this one without having to chase sponsors. Lucas: Alright, back to the 529. One more thing I want to flag: the Secure Act 2.0 allowed 529 funds to be rolled over into a Roth IRA for the beneficiary, up to thirty-five thousand dollars over a lifetime, subject to contribution limits. That's a huge development because it means if you overfund the 529 — maybe because you were conservative and overestimated inflation — the excess isn't trapped. You can move it into a Roth for your child. Luna: That changes the calculus a bit. It means being a little too aggressive in saving isn't as penalizing as it used to be. You can overshoot and still use the money for retirement. Lucas: Right. So the inflation hedge strategy now has a safety valve. But the key is still to model your target properly. And for that, you need a realistic tuition inflation assumption. I'd suggest using three percent above CPI as a baseline, but check the College Board's trends data for the most recent figures. For the current academic year, they reported a 3.5 percent increase in published tuition and fees at private four-year institutions. Luna: So CPI plus three to three point five percent is a good range. And with CPI running at around two point five percent year-over-year based on the June data, you're looking at total tuition inflation of around five point five to six percent annually. Lucas: That's the number that should be driving your savings plan. Not the stock market's return, not the Fed's rate decision, but the gap between what you expect your investments to earn and what college will cost. And that gap is where inflation quietly does its damage. Luna: So the takeaway: check your 529's inflation protection, run the net present value, and don't assume a target-date fund will handle everything automatically. Lucas: And if you're not sure where to start, just look at your most recent statement. Find the 'current balance' and the 'projected cost at enrollment' if your plan provides it. If the balance is less than half of that projected cost, you're behind. Then you can decide whether to increase contributions or adjust your investment mix. Either way, being aware of the inflation drag is the first step.