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Susan Tompor: 3 ways to protect your kids’ college savings if the market falls

McClatchy-Tribune Information Services

Oct. 15, 2018


The record run for stocks — along with ongoing trade and election jitters — has some parents on edge about college nest eggs.

After all, you might be able to delay retirement if the market tumbles and your 401(k) takes a hit. Not so much if your 529 plan implodes.

For savers, we’re not talking about chump change. Families had nearly $329 billion invested in 529 plans, as of June 30, according to the College Savings Plan Network, a coalition of state-run 529 plans. That’s about double the amount in 2011.

A record 13.6 million accounts exist — with the average account size reaching a record high of $24,153 as of June 30.

Many college savings plans are fatter, thanks to the strong bull market.

So what do you do if you’re worried about how long the good times will last, now that you’re sitting on enough money to cover a year or two or, maybe even more, of college?

— Whatever you do, don’t panic and cash out

Simply pulling money out of a 529 plan to park in a savings account somewhere until your child heads to college is a very bad idea.

If you’re just cashing out of a 529 plan now because you’re nervous about stock prices, you’d take a tax hit. In this case, you’d be taxed on the earnings withdrawn at the account owner’s rate. Plus, you’d pay a 10 percent penalty on the earnings — not the entire amount you’ve withdrawn.

By contrast, you avoid those taxes and penalties if the money is withdrawn to cover “qualified 529 expenses” when the student is in college. Beginning in 2018, qualified withdrawals also include up to $10,000 a year per beneficiary for tuition expenses for elementary, middle and high schools, said Melissa Ridolfi, vice president of Retirement and College Products at Fidelity.

A key point to understand: You must request a cash withdrawal from a 529 plan during the same calendar year as you make the payment. If the timing is off, you risk owing tax because it will be considered a nonqualified withdrawal.

Eligible expenses at colleges, universities and other post-secondary institutions include tuition, books and supplies, room and board, a computer and special equipment required by the school or class, according to FINRA’s tips for tapping your 529 plan.

Expenses that aren’t covered include travel expenses to and from campus, campus logo sweatshirts and computer games.

“If you are nervous, don’t pull out of the plan altogether, but change the investment to a fixed or safer option,” said Leon LaBrecque, managing partner and CEO, LJPR Financial Advisors in Troy, Mich.

“You can change the investment without incurring the penalty, if you stay in the 529,” he said.

Take time to review what investment options exist in the 529 plan. You may be able to shift money to sidelines within the 529 plan or to more conservative options.

Remember, though, 529 plans should be invested for the long term. But if your child is a junior in high school, time is running out and you don’t want all the money sitting in stocks.

“529 plans should be invested for the long term,” said Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com.

“When the stock markets get more volatile, people panic. But, the worst thing you can do is pull the money out, since that will lock in losses and may cause you to miss the recovery,” he said.

“A better approach is to increase the amount you save each month, to compensate for the losses. Fear is the wrong reason to sell stocks.”

— Take a good look at how you’re investing money in that 529 plan

Do you have most of your money invested in an aggressive-growth or a growth-stocks index portfolio, which could have 100 percent of those funds invested in stocks?

Many states offer a prepaid tuition plan based on today’s rates and then paid out when the beneficiary is in college — so you’re not watching the ups and downs of the stock market here.

Other 529s are investment-based plans that will fluctuate in value based on the market performance. How much money you end up with in the plan in time for college will depend on how much you save and how well you invest.

It’s possible you are not taking on as much risk as you think. Many times, 529 plans are invested in age-based options that tend to have more money in stocks when the child is younger.

If your money is invested in one of these options, assets are automatically rebalanced as the child gets older. As the child moves into high school years, the money is gradually shifted out of stocks into a mix that leans more heavily on bond index funds, inflation-linked bond funds and guaranteed investment options, which offer minimal returns but safeguard your money.

“We usually suggest that parents go aggressive for the first 12 to 14 years, then shift to the moderate age-based allocation,” LaBrecque said.

The assumption is that if you start saving when the child is an infant, you might be able to weather the market risks of being heavily in stocks in the next 12 years or so.

Some market volatility is useful in the early years as you’re building savings because you’re buying stocks at lower prices and taking advantage of dollar cost averaging, he said.

When the child is 12 or so, though, the next eight years or more going all the way through college would need to focus more on preserving your college savings, LaBrecque said.

If someone is heavily invested in stocks — and not using age-based funds — it’s wise to start moving a bit more than 10 percent a year into some short-term or fixed option every year beginning when the child hits age 14, he said.

That way, you’d have at least 50 percent or so of the money away from the stock market once the student starts college.

You’re moving money, based on a child’s age and ability to withstand some market fallout — not because you’re trying to outguess where the stock market is headed after the midterm elections or turns in the trade war.

If you’re not invested in an age-based option, you may be taking on more risk than you realize. You would not want to leave most of that money in the stock market when the student is in high school.

“As you’re nearing college, you want to make sure you’re protecting those assets and you rebalance, if necessary,” said Ridolfi at Fidelity.

— Understand some key 529 rules

Under the current tax law, one can change investment options twice every calendar year in a college savings plan and when there is a change in designated beneficiary.

So you’re not stuck once you make an investment decision.

It is possible to move into less-risky options along the way. If your child is in college already, you may want to shift more money into short-term investments, such as interest-accumulation portfolios.

If you don’t pay attention, your college nest egg could get cracked by a nasty turn on Wall Street.