How to handle a market downturn in your ‘529’ plan when you need to exploit it soon

The market downturn over the past few months could not have come at a worse time for parents sending a child to college later this year, with many seeing the balance in their ‘529’ college savings plan suffer. It’s the pre-retirement equivalent of yield streak risk, where a market downturn can permanently depress balances, but likely with less time to recover.

Qualified Tuition Plans, or 529 Plans, are tax-advantaged accounts typically used by parents, grandparents, or guardians to pay for the education costs of a child or grandchild. The most common type of 529, an education savings plan, can be used to pay tuition, compulsory fees, and room and board at just about any college, university, or college program. recorded learning. Up to $10,000 per year for each beneficiary can also be used for K-12 education expenses, such as tuition at private or religious schools.

Investments in these 529 accounts grow tax-deferred until the money is withdrawn, and withdrawals are exempt from federal and most state taxes as long as the money is used for household expenses. qualified education. Otherwise, withdrawals are subject to state and federal income taxes and an additional 10% federal penalty tax on earnings.

Internal Revenue Service rules prohibit individual investments such as stocks, mutual funds, or exchange-traded funds. Typical investments in 529 plans include mutual fund portfolios, ETFs, and other securities calibrated to account holders’ risk tolerance, and many state plans offer target date fund portfolios. or age-based which aim to reduce risk as the beneficiary ages. .

Although target date plans may have reduced savers’ losses during the recession, it is likely that some savers kept most of their money in riskier options even as their children approached college, given of the stock market’s strong performance in recent years, said Mindy Yu, chief investment officer at Betterment at Work. The company’s services include student loan servicing and plans to launch 529 products later this year, she said.

“There’s been a lot of euphoria over the last few years because basically everything you were investing in the market was just going up,” Yu said. being too aggressive, thinking there will be this continued growth.”

If your 529 account balance has recently been impacted and you need to tap into it quickly, there are some options to minimize the erosion and allow time for a market rebound, finance professionals say.

On the one hand, Yu said, it might make sense to pay some or all of a child’s school fees using other assets, such as money from a brokerage account or savings in cash. species. While this approach may trigger a tax bill, it could also buy time for a rebound that allows you to cover more education expenses in later years.

Another option suggested by Yu: continue to contribute to 529 plans and give their existing assets time to recover, even if it means a child has to take out student loans. She points out that the S&P 500 index has averaged annual returns of around 17% from 2012 to 2021, well above the interest rate of a typical student loan. The federal student loan interest rate for undergraduates was set at 3.73% for the 2021-22 school year, although it is likely to increase this year.

“If you’re continuously contributing to your 529, you’re actually able to enter the market at a lower price, so contributing to your 529 still makes sense in this market environment,” she said.

In addition, 529 beneficiaries are entitled to tax-free withdrawals of up to $10,000 in total to repay their student loans. An additional $10,000 can be withdrawn to pay student loans for each of the beneficiary’s siblings. If a beneficiary does not need or use money from a 529 plan, the account holder can transfer the plan to another child or family member.

A tempting source of funding should be prohibited. Rob Williams, Managing Director of Financial Planning, Retirement Income and Wealth Management at

Charles Schwab

said it discourages savers from borrowing or withdrawing funds from their retirement savings accounts to pay for a child’s education.

When it comes to student loans, he warns parents to consider how much money their children are likely to earn early in their working careers.

“It can be tempting to take out a lot of student loans, but they have to be repaid,” Williams said. “So be very mindful of student loans, where the kid is majoring, and how likely they are to go into a career where they can repay those loans.”

Looking ahead, he said parents can protect themselves from downturns by de-risking a few years before they need to operate a 529. When teenagers enter high school, for example, parents should start trading riskier investments in their 529 plans versus more conservative options.

“Four or five years before a kid goes to college, that’s definitely the time to start cutting it down a bit, slowly and gradually,” Williams said. “Certainly, a year or two before you need to withdraw money, it’s probably good to reduce the risk a little more. This is the prudent strategy.

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