How to Fix the Cash in Your 529 Plan

Summary: Many 529 Plans use stable value funds as their cash holding. When interest rates rise significantly, like they have recently, these funds often return much less than money market funds. Better options may be available for investors willing to change their holdings. 

Now is an extremely important time to check on the cash in your 529 plans. Many people assume that because money market funds are offering 5% rates of interest, so too do similar investments in 529 plans. Not so. Take the popular Nevada Vanguard 529 Plan. It offers just one cash investment option and the yield is just 2.59% as of November 20th. If you compare the rates of return for the cash investment vehicle in many of the largest 529 plans, you will find that they are significantly below what popular money market funds are earning. Below is a chart of the some of the most popular 529 plans in the U.S. and whether the cash options they offer are significantly underperforming money market returns this year:

 Sources: Respective 529 plan websites, reviewed as of 9/30/2023.

The same below average interest rate applies for the cash component of many of the 529 target enrollment funds. That means that if your child is already in college or soon to enroll, your 529 money may be earning thousands of dollars less than you think.

The reason this is happening is because of the type of fund being used in many plans, combined with the rapid recent rise in interest rates. Many 529 plans use what is called a stable value fund for cash-like investments. Stable value funds are similar to money market funds in that they are designed to never go down in value, but in practice, they can have returns that are quite different, especially during times of rising interest rates. 

To get technical, stable value funds typically purchase short term bonds as well as guarantees from insurance companies to prevent the funds from losing money if the bonds owned drop in value. This approach is less than ideal in periods of time (like now) when bond yields have risen quickly following many interest rate hikes. 

The problem for stable value funds is that they still own many lower yielding bonds they purchased a few years ago. This limits the interest rate they are able to pay today.

In contrast, money market funds do not hold investments for very long, often replacing all their investments every few weeks. That means their holdings are recently issued higher yielding investments, allowing them to outearn stable value funds by a meaningful amount. In stable value funds’ defense, when interest rates hold steady or drop, they tend to outearn money market funds and so over long periods of time, they usually do better than a money market fund. 

Suggested Steps

If you are about to spend money on college, your time horizon is short and you need to know what will earn you the most tuition money now. Here are some suggestions to take to help you maximize your dollars:

Research Your Options - Find out how much interest the cash in your 529 plan is earning. If the interest rate (or year to date returns) are well below the returns of popular money market funds, that’s a good sign that it’s a less than optimal choice today. 

Consider Switching Funds Within Your Current Plan -  Fortunately, some 529 plans offer multiple cash options, making switching to a higher earning fund easy. The Utah my529 plan (Gold rated by Morningstar and one of the top 10 largest 529 plans), offers both a stable value fund and a money market type fund (Utah’s FDIC-Insured option). As of September 30th, the FDIC-Insured option has returned almost 2.5% more than the stable value fund. 

Unfortunately, plans like New York's 529 Program (Direct), Nevada’s Vanguard 529 College Savings Plan and California’s ScholarShare College Savings Plan only offer a stable value fund for cash investments. Additionally, their target enrollment date options invest as much of 60% of the entire fund in the stable value funds. Even Utah, which uses multiple cash options in their enrolled student target option, has 20% in a stable value fund. 

If your plan does not offer a more competitive cash-like fund, you have a few alternatives. Most plans offer a bond index like the Total Bond Market Index. However, a bond fund, unlike a stable value or money market fund, has the potential to lose money, especially if interest rates move higher. 

Carefully Consider a 529 Rollover - Another possibility is to actually roll over one’s 529 plan to another state’s 529 plan, but there are quite a few wrinkles to that - including an IRS limitation on how often one can make a rollover and recapture rules in certain states (including NY) that create a tax bill for rollovers. Accordingly, you really need to do your homework before doing a rollover and swapping to a different plan. 

Investigate Recreating Your Target Enrollment Fund - And what about those in target enrollment funds heavily invested in a stable value fund? It may make sense to move out of the target enrollment fund and into your own version of the target enrollment fund. For instance, for those in the Utah plan, one could mirror the allocations of the target enrollment fund, investing in the same amount of the underlying investments (i.e. 7% in the Total Stock Market Index Fund, 5% in the International Stock Index Fund, etc.), but swapping out the stable value fund for the higher yielding cash option. Alternatively, if one is able to rollover penalty-free to another 529 plan, moving the assets to a plan with more investment options could be a reasonable decision. 

Bottom Line: Periodically check the options in your 529 plan. While stable value funds are generally attractive options for cash holding needs, in today’s interest rate environment, you may be able to earn more by swapping your stable value fund for a different option. If you would like to discuss your specific 529 situation, please feel free to reach out directly.

Jonathan Bernstein is the lead advisor at Bernstein Planning and Investment Management.  Jonathan graduated from Yale College and has worked in financial advising for 17 years. He previously served as Director of Research for Hefren-Tillotson, Pittsburgh’s largest independent wealth manager, managing over $18 billion of client investments. Jonathan is both a CERTIFIED FINANCIAL PLANNER™ certificant and a CFA® charterholder.