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Pick up the pieces of 529 college-savings plans

You've said yes to the college your child will attend next fall, but the hard part remains. How to pay? The uncertainty is especially painful for parents who expected college savings to be tucked away in 529 savings plans by the time the bills st...

You've said yes to the college your child will attend next fall, but the hard part remains. How to pay?

The uncertainty is especially painful for parents who expected college savings to be tucked away in 529 savings plans by the time the bills started to arrive. But the financial crisis brutalized those intentions.

According to a survey of parents with 529 savings plans by scholarship-search provider FastWeb, more than half lost money as stocks took a beating and bond losses far exceeded the norm in 2008. As they tried to hold on to what money remained, many parents solidified their losses by selling off and gaining little or nothing when stocks soared after hitting bottom in March 2009, said Mark Kantrowitz, publisher of FinAid.org and FastWeb.com.

Between October 2007 and March 2009, stocks fell about 57 percent, and some bond funds dropped 30 percent from exposure to mortgage-related securities. Nearly a quarter of parents in the FastWeb survey said their 529 plans lost at least 30 percent in 2008, and those with the greatest losses were twice as likely to move their money to safety. So, they missed out when stocks climbed, Kantrowitz said.

The survey found that a third of parents with losses stopped contributing to 529 plans, and two-thirds of those with losses of more than 30 percent stashed away no additional money. On top of market losses, about 10 percent said they yanked money from 529 plans. If those withdrawals included prior gains, they would have owed the IRS penalties and taxes.

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To amass tax-free savings in state-operated 529 plans, the money must be used for college. Kantrowitz is urging Congress to allow parents to leave money in 529 plans through college and withdraw it afterward without tax penalties. Such action, he said, would help parents whose money is intact let it grow and pay off loans with it in the future. Three-quarters of parents in the survey said they favored the idea, but there is not a bill before Congress yet.

Still, parents could consider other options:

BUYING TIME: Those still waiting for their savings to rebuild could borrow money for a year or two of college and use 529 savings for the remaining years or graduate school. Contributions are limited to $26,000 per child per year for a couple; half that for an individual.

Be aware that you cannot count on the stock market to keep rising and restore your money quickly. Conservative 529 plans, and many financial planners, do not recommend stocks in savings programs for students age 17 or 18.

Families trying to regain losses should evaluate their 529 plans and make sure investments are appropriate for the age of their children at tinyurl.com/3ysoo79. Select a 529 plan with low fees, one with an expense ratio of 0.50 percent or less. Compare plans at Savingforcollege.com. You can switch to a plan in another state every 12 months.

SHIFTING GEARS: Financial planner Raymond Loewe suggests that people close to retirement use 529 plans for their own college studies, perhaps a course that includes foreign travel.

You could change the beneficiary from your child's name to your own and amass money until you study in retirement. Be aware, however, that to use a 529 appropriately without being taxed or penalized, the course must be recognized by a legitimate educational institution and 529 money must pay for tuition, said Joe Hurley, founder of Savingforcollege.com.

GET TAX MONEY BACK: If you lost money in a 529 and bailed out in the downturn, you might be able to claim the loss as a miscellaneous tax deduction if it amounted to at least 2 percent of your income, Hurley said. For a previous year, file an amended return. And, despite the condition of your 529, you can take student-loan interest deductions and a tax credit of up to $2,500 a year for college tuition.

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