college

529 plan: Moves to make now

The notice at the bottom of every advertisement for a 529 savings plan includes the warning: "Accounts may lose value." Millions of disheartened parents are now all-too-aware of just how accurate that statement is as they open their September account statements and see that their 529 savings accounts have, in fact, lost money. The stock market swoon of recent weeks has not only caused account values to drop but in many cases has created losses, as balances drop below original contributions.

So what are parents to do as they fret about losing money in their college savings accounts at the same time that college costs continue their relentless rise? Here are some suggestions, based on the current age of your child.

Ages 0-10 
Take a deep breath and resist the urge to flee your 529 plan. Of course your account is down, but going forward, the stock market still offers the best chance for your college savings account to appreciate at a rate that keeps up with college cost increases. You'll have to stomach the ups and downs along the way, but, if history is any guide, you should be rewarded in the end. In fact, with stocks currently on sale -- at least according to Warren Buffett -- you may want to pump as much cash as you can into your 529 plan. By investing in your 529 plan's age-based option, you'll be in position to benefit from a stock market rebound and can rest assured that by the time your child gets close to college age, your account will have automatically been switched to lower-risk bonds, money market or stable-value funds.

Ages 11-16 
Any money you already have in your 529 plan has probably taken a hit, but you have at least a couple of years before the college bills start coming. Are you bullish on the stock market over the midterm, or do you think the sinking economy suggests a protracted bear market? If you are bullish and willing to accept some market risk, you may want to switch to one of the "static" options in your 529 plan that stays invested mostly in stocks. Sticking with an age-based investment option has the unfortunate consequence of locking in your current losses as it shifts from stocks to bonds and money market funds. If you believe the market still has substantial downside momentum, you may want to head in the opposite direction and switch now to the most conservative option in your 529 plan --either a money market portfolio, a guaranteed or stable-value portfolio, or a bank CD option.

Ages 17 and older 
You are going to be pulling your money out of the 529 plan over the next few years, so why take on the risk of a volatile stock market? If you've been using your 529 plan's age-based option, you should be feeling relatively well-protected as most accounts in the age-based portfolios for college students and soon-to-be college students have held up nicely so far this year. However, if you opted for a 100 percent equity option, you are feeling substantial pain as the realization hits home that the depressed value of your account means you may have to take on more student loans than originally planned. If you don't have enough saved in your 529 plan to cover the full cost of college, you may want to target the use of your 529 funds to the last couple of years of college, hoping for a recovery in the meantime. Otherwise, you should consider cutting your losses and switching to the money market or guaranteed option in your 529 plan so you don't suffer any more if the markets continue heading south.

All ages 
If you decide to switch investment options in your 529 plan, remember that your plan will allow only one switch in any calendar year. You can also change investments via rollover to another 529 plan, but only one tax-free rollover is permitted in any 12-month period. In either event -- investment switch or rollover -- the timing restrictions can be avoided if you change the beneficiary at the same time. For example, with two children, you have maximum flexibility, since beneficiaries can be changed between siblings as often as you wish with no consequences (Warning: Intergenerational beneficiary changes can give rise to gift-tax problems).

Tax strategies 
With stock values at such low levels, you may want to consider making some tax-saving moves with your college savings. One such strategy would be to liquidate and request a refund of all of your 529 accounts, but only if they net out to a loss. You pay no federal tax or penalty, and the loss can be claimed as a miscellaneous itemized deduction on your income tax return. The problem with this strategy is that miscellaneous itemized deductions may offer little or no tax relief due to the 2-percent-of-adusted-gross-income threshold as well as the workings of the alternative minimum tax. Then the question becomes: what to do with the proceeds. If you want to put the money back into a 529 plan, you'll have to watch out for the "wash sale" rules, for unintended rollover treatment and for gift-tax consequences. You also need to look into the consequences of any such move for your state income taxes.

An even better tax-saving strategy may be to take advantage of the depressed market by liquidating your non-529 investments (e.g., stocks and mutual funds) at low capital gains cost -- perhaps even generating a tax-saving capital loss -- and reinvesting the proceeds in your 529 plan, where future earnings can accumulate tax-free. This opportunity won't last long if the markets spring back faster than expected.

In any event, don't let the stock market keep you from working toward your college-savings goals. For most families, 529 plans still offer attractive benefits, if you believe the economy will eventually right itself. Depending on where you live, you may even be able to claim a state income tax deduction for your contributions -- a benefit you keep regardless of stock market performance.

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