The severe bear market has pounded away at almost everyone’s investment portfolios and retirement plan accounts. But those aren’t the only investments that have been mauled. The turbulence on Wall Street has also hammered Section 529 plans designed to build up savings for college. The problem is especially acute for those who need to withdraw funds within the next few years.
A Section 529 plan is a tax-favored way to save for a student’s college education. For starters, you can set aside generous amounts in a state-sponsored savings plan. There’s no current tax on accumulations within the account, and distributions are tax-free if used to pay for tuition, room and board, and other qualified college expenses.
There are two basic types of Section 529 plan: the prepaid tuition plan and the college savings plan. With the former, you can lock in payment for future tuition by purchasing credits at a specified rate. Suppose this year’s tuition at a public university in the state sponsoring the plan is $6,000. Invest $3,000 now for a four-year-old child, and you’ll be guaranteed a credit for half a year’s tuition when the student matriculates, even if costs have doubled or tripled by then. This type of plan protects you from investment downturns because the school assumes the risk—not you. You’re essentially buying tuition inflation insurance, which can be a pretty good deal at a time when college costs are rising much faster than the overall cost of living. In fact, some states offering such plans are having trouble making good on their end of the bargain.
With college savings plans, however, you’re the one taking investment risk. These plans, also sponsored by states but generally available to out-of-state investors as well, let you spend your money on any public or private college. And though the investment menus vary widely from one 529 to the next, many plans offer a range of options similar to those in a 401(k) retirement plan. Most provide age-adjusted accounts that shift from more aggressive, stock-dominated portfolios when a child is young to more conservative, largely fixed-income allocations when college age approaches. But investors also may be able to choose all-stock accounts. Those seemed like a good deal when share prices were rising, but the recent market plunge has hit such accounts particularly hard.
The question, of course, is what to do now if your child’s account has suffered deep losses. You may need to reconsider your investment allocations, and a new IRS rule, in effect only for 2009, permits you to shift investments within a plan twice rather than just once during the year. Your first step, as painful as it may be, is to look at your current 529 account balances and project what they’ll be when your student starts school. Then consider possible changes to your strategy.
- If your child is graduating from high school soon, damage control is in order. It may be tempting to roll the dice on stocks, hoping to recoup some of your losses, but at this point preservation is much more important than growth. An allocation dominated by bonds or cash investments probably makes sense.
- If you have younger children too, consider changing the 529 plan beneficiary to someone who won’t need the funds until the markets have had a chance to recover. Or simply delay making withdrawals until the later years of college. These strategies assume you have other funds available to pay near-term expenses.
- If college is still years in the future, having much of your plan invested in stocks could still be a good idea. Share prices have taken a big hit and may fall further, but being patient and staying invested for the eventual rebound may reward you nicely. Even so, choosing a diversified investment option could minimize volatility and increase potential gains.
- Switching to a prepaid tuition plan now could relieve you of future investment risk. But it will lock in your 529 plan’s losses and also limit your child’s choice of college.
- Increasing current contributions to college accounts could also help make up for the market plunge. With college costs rising quickly and potential sources of financial aid shrinking, having personal savings to draw on will be more important than ever in the years ahead.
Of course, education savings is only one of your many financial priorities. We can help you assess your current situation and work with you to make sure your overall financial strategy remains on track. We can also assist you in filing FAFSA forms.