Should I divest myself of REITS in my 529 plans?

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idoc2020
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Should I divest myself of REITS in my 529 plans?

Post by idoc2020 »

One year ago I made the decision to invest my kids' entire 529 plans in REITS (the virginia 529 program allows for 100% VNQ). I bought about $350K of VNQ in these plans and considered it as the REIT component of my AA. The objective was to place a highly tax inefficient instrument in the most tax efficient plan possible. Naturally, REITS have had a disastrous year and the portfolio has lost about 50%. Fortunately, my kids are 2 and 6 years old and are not in immediate need of the money. However, I would welcome some advice regarding this approach:

1. Was the original thinking correct to place the most tax inefficient instrument in a 529?
2. Is it reasonable to think of the 529's as just part of my AA as a whole? I think this has been covered before on the forum and the conclusion was that it was reasonable.
3. Should I perhaps have invested TIPS, BND or some other form of bonds in the 529 instead? My feeling at the time was that since I had so much time I anticipated that REITS over the long term would appreciate more than bonds.
4. Is it plausible that ultimately REITS will do so badly in the long term that the kids won't really have sufficient funds?
5. Does it seem likely that the remaining $200K in these two funds will suffice for a 2 and 6 year old? Or should I supplement this further (I have not maxed out yet on what I can put in)? When I put in the initial $350K for the two of them I thought that I was "done" with my college obligation for them. Am I not quite done?

Thanks in advance for any advice.
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grabiner
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Re: Should I divest myself of REITS in my 529 plans?

Post by grabiner »

ilan1h wrote:One year ago I made the decision to invest my kids' entire 529 plans in REITS (the virginia 529 program allows for 100% VNQ). I bought about $350K of VNQ in these plans and considered it as the REIT component of my AA. The objective was to place a highly tax inefficient instrument in the most tax efficient plan possible. Naturally, REITS have had a disastrous year and the portfolio has lost about 50%. Fortunately, my kids are 2 and 6 years old and are not in immediate need of the money. However, I would welcome some advice regarding this approach:

1. Was the original thinking correct to place the most tax inefficient instrument in a 529?
It was correct to put it somewhere tax-sheltered, this could have been an IRA or a 401(k) instead of a 529, but if the rest of your investments are all taxable, then putting it in the 529 was reasonable.
2. Is it reasonable to think of the 529's as just part of my AA as a whole? I think this has been covered before on the forum and the conclusion was that it was reasonable.
Yes, provided that you have some other source you can tap for the college money without a large penalty. Taxable investments held elsewhere would be fine.
3. Should I perhaps have invested TIPS, BND or some other form of bonds in the 529 instead? My feeling at the time was that since I had so much time I anticipated that REITS over the long term would appreciate more than bonds.
You should have a college funding portfolio; since the children are 2 and 6, you might make that portfolio 80% stock. This portfolio would then be part of your overall asset allocation. If you lost a lot in the 529 but gained by holding Treasury bonds in another account, you are no worse off than if you had the REITs and bonds in the same account.
4. Is it plausible that ultimately REITS will do so badly in the long term that the kids won't really have sufficient funds?
If this is the only source for their college funding, it might be inadequate, because REITs are very volatile.

But if you can sell your taxable stock if necessary, they will have sufficient funds from some source.
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Post by fundtalk »

I don't personally consider my 529 in my overall asset allocation (which is essentially my retirement funds.) My kids will need their 529 money at a different time than I will need my retirement money. I have a different time frame and risk tolerance for this money. I keep it in a conservative age based asset allocation that self adjusts over the years. Having it all in a sector fund does not seem like a reasonable allocation to me.
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Sammy_M
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Post by Sammy_M »

ilan1h,

Do you have taxable investments? If yes...If your taxable investments do well and your 529 investments do poorly, will you pay less of your children's education? If no... proceed as you're doing. Look at it as a unified portfolio and pick the best location/lowest cost path to implement your chosen investment strategy.

If you say no to the first, or yes to the second question, maintain a separate asset allocation for college savings.

I use the VEST plan for REITs and TIPS. I may use TBM in the future too.
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idoc2020
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Post by idoc2020 »

Sammy_M wrote:ilan1h,

Do you have taxable investments? If yes...If your taxable investments do well and your 529 investments do poorly, will you pay less of your children's education? If no... proceed as you're doing. Look at it as a unified portfolio and pick the best location/lowest cost path to implement your chosen investment strategy.

If you say no to the first, or yes to the second question, maintain a separate asset allocation for college savings.

I use the VEST plan for REITs and TIPS. I may use TBM in the future too.
My initial plan was to put a lump sum of money into the 529's for the kids and to "never think about it again". The reason why I committed such a large sum was that if anything happened to me or to my money, at least my kids' schooling was assured. I was more concerned about taking care of their education than funding my retirement. I reasoned that if the $300K tripled they could both live high on the hog at ivy league schools. The money would easily suffice. However, if the $300K did not appreciate sufficiently, they could take out student loans. Either way, as far as I was concerned I never needed to worry about the kids' education again. The only silver lining to the funds' decline is that my wife and I have concluded that both these kids are rather doltish and it is highly unlikely that they will ever go to university. :D
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celia
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Post by celia »

I think your original thought process was correct, and under similar circumstances I would probably have done the same. Without knowing what the future stock market and real estate would do, you probably could have improved it slightly by cost-averaging over time. This is a form of diversification, in my opinion.

However, I wonder why you put in so much for 2 children. Wouldn't you put in today's cost of 4 years of college and expect that the account would grow about the same as the annual cost of attending a university. Some universities cost $50,000 a year, but most do not. Maybe you were hoping for med school???

I'd caution you, however, to keep a check on what you think of the kids' abilities. Kids have a way of sensing this and living up to your expectations.
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Post by Tramper Al »

I take the same approach, funding 529s early and somewhat aggressively, then considering that space as a tax-favored location within the overall portfolio. Hence, the kids' equities for college are in taxable, rather than the sizable 529s.

My situation is the opposite of the OPs, as all our 529s are and have been 100% TIPS. So as the portfolio as a whole has crumbled in value, the 529s have become a larger and larger percentage of the whole. And that's OK. I would still spend all the 529s balance that I can on educational expenses, regardless. Still 14 years out from that first tuition bill.

Sure, over the years I may temporarily hold some equities or REITs in the 529s for TLH swaps or whatever. But I think one considerable risk with a big 529 is that it gets too big. Until it is spent for education, that tax-free status is just a wishful assumption. Or else for grandchildren. I might make all the 529 space 100% REITs for w while, but if it reached too big a balance (vs. college costs), I'd have to shift and hold those REITs in a retirement account again, as I do now. I think $350K for 2 kids would be well into the range when I'd worry about being able to use most of it for education - at least for that generation.

In other words, in the whole portfolio approach, I don't mind having retirement cash/bonds in the 529 and college equities in taxable, but I think there is some location mismatch risk in doing the opposite.
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idoc2020
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Re: Should I divest myself of REITS in my 529 plans?

Post by idoc2020 »

I am updating this thread after 11 years! I did not divest my 529 from REITS and even doubled down on them during the intervening years. When I first made this post I think VNQ (Vanguard REITS) was under 26. It is now closer to 126. I have one child who began his college education this year at one of the most expensive schools in the country, and another who will be starting soon enough. The 529 was a real gift because even though VNQ was purchased with post-tax dollars it was allowed to grow and to be distributed entirely free of taxes. It is probably one of the most tax inefficient investments but did very well in the 529 structure. Having said that, I would include the caveat that one has to be prepared (and able) to financially supplement a college education before choosing risky investments in a 529. I didn't have to do this but I was prepared for this eventuality.
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Re: Should I divest myself of REITS in my 529 plans?

Post by Fattire00 »

idoc2020 wrote: Sat Oct 16, 2021 1:10 pm I am updating this thread after 11 years! I did not divest my 529 from REITS and even doubled down on them during the intervening years. When I first made this post I think VNQ (Vanguard REITS) was under 26. It is now closer to 126. I have one child who began his college education this year at one of the most expensive schools in the country, and another who will be starting soon enough. The 529 was a real gift because even though VNQ was purchased with post-tax dollars it was allowed to grow and to be distributed entirely free of taxes. It is probably one of the most tax inefficient investments but did very well in the 529 structure. Having said that, I would include the caveat that one has to be prepared (and able) to financially supplement a college education before choosing risky investments in a 529. I didn't have to do this but I was prepared for this eventuality.
That was good fortune. I did look up VNQ and it’s now $83, as I was curious how it survived the rare increases and commercial property vacancies.

(Perhaps the one critique I have on your bond funds and REiTs is that you left yourself quite exposed to interest rate movements and there was no room for them to go lower so the risk was asymmetric. It’s a concern to me that people find binds less risky yet they were extremely risky when rates got so low, as became clear. )

I funded my two children’s 529’s in 2009 exclusively in the s&p 500 when they were slightly older than yours were. The 5 year max was $135k each believe. Because I was bullish on the market then and wanted to really fund their college at those market rates, I actually funded one for myself at $135 (that’s allowed). The s&p went up about 3.5x. I switched to very short term bond funds when the markets started cracking a few years ago. My kids are both getting close to graduation and the allowable reimbursements for school is over $80k each per year. Even so, the 529’s remain well over funded. (And I am allowed to transfer mine by usin a gift tax as well).

The issue therefore is what to do with the excess. A few things happened
1. Could use it for private high school though that came a bit late for us to really use m
2. Can switch up to $35k per child (and me) to a Roth without incoming testing provided the account has been open 15 years, subject to the annual contribution limit so it will take several years.
3. I started paying my siblings children’s college expenses as well
4. One of my children is going to grad school where the annual tuition - not including room and board) is $80k! Wow. But it feels like the 529 is now “free money.” To take anytHIn
Grout would be a high income tax plus the 10% penalty on gains.

However, it then becomes a great estate vehicle as well as money doesn’t need to be taken out. Otherwise overfunding it with the penalty and ordinary income taxes on withdrawal and lack of ability to deduct losses makes it costly to consider doing.

Unless one does plan on leaving an estate I’m not sure I would get close to where it could be overfunded. Can’t really complain though as the s&p (and apparently the OP’s REIT) performed so well it created the high class problem going forward it will probably be a lot different. I wouldn’t have thought that the market would outperform the college inflation rate.
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