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529 Plans in the Post Crash Era

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We talked a few weeks ago about how the stock market crash is going to affect college savings plans.  I mentioned that those of you with plans to attend school in the next year might be feeling a real pinch. Before you completely panic, I decided to take a look at what the experts are saying about 529 Plans – both for those of you who are in school, or about to start, and for those parents who are wondering whether they should still invest for their children’s future.

Quick Reminder: What is a 529 Plan?

There are two different kinds of 529 Plans: college savings plans and prepaid tuition plans. Prepaid plans let you buy tuition credits at today’s prices and guarantee them for the future. In today’s market, this might seem like a safer bet, but keep in mind that prepaid plans limit a student’s options in terms of what school they will attend.

A college savings plan is a managed investment portfolio, where your money is invested in some savings vehicle, usually mutual funds of stocks or bonds. The risk is greater than with a prepaid plan, since you are not guaranteed a rate of return (in this case, X number of tuition credits).  But, if your college savings plan does well, you can earn a lot more in interest than with the prepaid plan.

In addition to the benefit of saving for college, both types of 529 Plans offer added tax incentives.  The money saved in a 529 Plan earns interest tax-free; and when the funds are used for an approved education expense (this is generally broadly defined), the withdrawal is also tax free.

How has the stock market crash affected college savings plans?
According to this article, 529 Plans have declined in value 9 percent since last quarter – even taking into account new investments. And that was before the bottom fell out of Wall Street.

It stands to reason, though, that aggressively invested 529 Plans will be seeing similar losses to the rest of the Dow Jones.  Since its record high one year ago on October 9, the Dow Jones has lost over 40 percent of its value.

Keep in mind, however, that most 529 Plans are set to become increasingly conservative as your child gets closer and closer to college age. Which means, if you child is about to start school next fall, your plan may have already converted to a majority bond position – and therefore have been spared most of the axe.  Definitely check your plan’s quarterly statement, if you haven’t already.

For those of you with more aggressive funds, the precipitous drop has undoubtedly cut your earnings (and likely your principle) dramatically.  The good news, though, is that (1) you still probably have time to recover and (2) your tax savings are still accruing.

What if I had a 100% Equity Plan and my child is about to start school?
Well, then, unfortunately, you are probably feeling substantial pain since your plan is not worth as much as you had counted on.  Your family may have to take out more college student loans that you planned – or make alternative arrangements (like considering a less expensive state school, or two-year community college).  Many parents of incoming freshmen are opting to leave their funds untouched for the next year or two, hoping the fund will bounce back in time for junior and senior year.  In the meantime, they are taking out loans or using other means to cover the costs of tuition, room and board.

Is a 529 Plan still a good investment for me and my child?
It absolutely is, according to Bankrate.com, which dispenses the following advice in this recent article on cnbc.com:

For parents of 0-10 year olds

  • Avoid the urge to flee, stay the course, you have plenty of time to recoup any losses
  • Be sure to chose a plan with an age-based option, though, so that as your child gets closer to college age, the risk factor will decrease

For parents of 11-16 year olds

  • Depending on your risk tolerance, you may actually want to switch away from your age-based option to a more aggressive, all-stocks option.
  • Sticking with an age-based investment option locks in your current losses when the plan shifts from stocks to bonds.

So, how has the current market situation affected your college savings?

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