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CDs add safety to 529 plans

By Sheyna Steiner · Bankrate.com
Wednesday, February 1, 2012
Posted: 12 pm ET

It's no surprise that the tremendous volatility in the stock market has scared investors away from stocks. According to the Investment Company Institute, the trade association for domestic investment companies, in 2011 investors fled equity funds in droves -- about $125 billion flowed out of stock mutual funds for the year.

For some investors, particularly those saving for college, the rate of return on savings ranks far below the safety of principal. For those investors, CDs may be just the ticket.

While CD yields are pitiful -- the average one-year yield is 0.34 percent -- they can be extremely useful products when savers or investors can absolutely not afford to lose a penny. A recent story from Reuters published Jan. 31, "Personal finance: Removing risk from 529 college savings plans," highlighted the popularity of the low-yielding but safe investments for college savers.

The 529 has long been popular with parents and grandparents because funds can be withdrawn free of federal and most state taxes to cover qualified higher education expenses. There is no doubt, though, volatile markets have yielded mixed results for the plans since 2008.

To encourage families to continue saving, many states have added bank products such as FDIC-insured savings accounts or CDs to their 529 line-up in recent years. The number of these more risk-adverse investment vehicles has nearly tripled, and they are now available in at least a dozen state 529 plans.

There are some caveats, though, when it comes to investing in CDs through 529 plans.

A Bankrate story from 2010, "CDs available in some state 529 plans," explored some of the drawbacks including yields that may not keep up with tuition increases and a lack of liquidity in the plans.

While traditional 529 plan options allow plan holders to shift funds between investment options without penalty, Rosenthal says those who pull out of certificates of deposit too early can lose some, and perhaps all, of the interest they gained from their plan. Before committing to CDs, Rosenthal encourages parents to get the facts on how long they'll have to stay with a particular CD and what happens if they pull out early.

Do you use CDs in your college savings plan? What has your experience with them been like?

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