How to Handle a Market Downturn in Your ‘529’ Plan When You Need to Tap It Soon

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The market slump in the past few months couldn’t have come at a worse time for parents sending a child to college later this year, with many watching their “529” education-savings plan balance take a hit. Is. This equates to pre-retirement-withdrawal risk, where a market downturn can deplete the balance permanently, but with less time to recover.

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Qualified tuition plans, or 529 plans, are tax-advantaged accounts, typically used by parents, grandparents, or guardians to pay for the education expenses of a child or grandchild. The most common type of 529, an education-savings plan, can be used to pay for tuition, compulsory fees, and room and board at any college, university, or registered apprenticeship program. 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.

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Investments in these 529 accounts are tax-deferred until the money is withdrawn, and withdrawals are exempt from federal taxes and most state taxes, as long as the money is used for qualified education expenses.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

Internal Revenue Service regulations prohibit individual investments such as stocks, mutual funds or exchange-traded funds. Typical investments in 529 plans include portfolios of mutual funds, ETFs, and other securities calibrated for the risk tolerance of the account holders, and plans in many states offer target-date, or age-based, fund portfolios that are aimed at the beneficiary’s. The risk is reduced as you age. ,

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Although target-date plans may have mitigated savers’ losses during recessions, it is likely that some savers put most of their money in riskier options, even if their children have seen the stock market’s strong performance in recent years. Hue arrived at college, said Mindy Yu, director of investments with Betterment at Work. The company’s services include student loan management, and plans to launch 529 products later this year, she said.

“There was a lot of excitement over the years because basically everything you invested in the market was growing,” Yu said. “So, this is a time when people can be overly aggressive, thinking that evolution will continue.”

Financial professionals say that if your 529 account balance has been affected recently and you need to tap it soon, there are a few options to minimize erosion and give the market time to return.

For one, Yu said, it makes sense to pay for some or all of a child’s tuition using other assets, such as money or cash savings from a brokerage account. While this approach can trigger a tax bill, it can also buy time for a rebound that will allow you to cover more education expenses in later years.

Another option Yu suggests: Continuing to contribute to 529 plans and giving your current assets time to recover, even if it means a child will have to take out student loans. She points out that the S&P 500 index averaged an annual return of about 17% from 2012 to 2021, which is much higher than the interest rate on typical student loans. federal student loan interest rate 3.73% for undergraduates was set for the 2021-22 school year, although this is likely to increase this year.

“If you’re consistently contributing to your 529, you’re able to enter the market at a really low cost, so contributing to your 529 still makes sense in this market environment,” she said.

What’s more, 529 beneficiaries are allowed a total of up to $10,000 tax-free withdrawals to pay off 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.

More on ‘529’ plans

A lucrative source of funding should be a no-go. Rob Williams, managing director of financial planning, retirement income and wealth management at Charles Schwab,
He said he discourages savers from borrowing or withdrawing money from their retirement savings accounts to pay for a child’s education.

For student loans, he cautions parents to consider how much money their children are likely to earn in their professional careers.

“It can be tempting to take out a lot of student loans, but they need to be paid back,” Williams said. “So, be very careful about the child’s principal’s student loans, and the likelihood of them going into a career where they’re going to be able to pay those loans back.”

Looking ahead, he said parents can protect themselves from a recession by mitigating the risk a few years before they need to tap a 529. For example, when teens enter high school, parents should begin swapping out the riskier investments in their 529 plans for more conservative options.

“Four or five years before the kid goes off to college is definitely the time to start scaling it up a little bit more slowly and gradually,” Williams said. “Sure, a year or two before you’ll need to withdraw some money, it’s probably good to reduce the risk a bit more. That’s a prudent strategy.”

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