It’s that time of year for dorm shopping and packing up the kids to head to college. It also means paying tuition and fees.
For parents using 529 plans to pay college tuition this year, some may have seen major losses in those plans due to market volatility. This year, the bond market and stocks both took a beating, erasing buffers in many investing portfolios, including 529 plans.
“We need to factor in the carnage in the bond market and this year's stock market losses which will devastate many 529 plan balances,” Jim Mahaney, a certified financial planner and principal at Mavericus Retirement, tweeted. “Especially those in age-based funds.”
That is forcing parents to withdraw after clocking in losses or consider other options for paying for this semester — depending on how their 529 plan is structured.
What are 529 plans?
529 plans are state-sponsored qualified tuition programs that can be used for education expenses like college or tuition for elementary and high school.
The funds grow tax-free. Although there's no federal deduction for contributions, many states offer a full or partial tax deduction. There are no income limits, age limits, or annual contribution maximums for 529 plans.
There are three major restrictions on 529 plans outlined in Prudential’s "Winning the College Savings Race." First, you can only change plan investments twice per year. Second, although you can transfer between different states’ 529 plans, you can only do it once in any 12-month period. Third, many states limit contributions on 529 plans after account balances reach a certain amount. For example, in New York the maximum account balance is $520,000.
529 plans have two options: a savings plan or a prepaid plan. Colleges and states can offer prepaid plans. Most families choose the savings plan, only offered by states. Similar to 401(k) retirement accounts, you can invest in mutual funds or ETFs. There are also “target date” plans known as age-based plans.
“When a child is young, it should be more aggressively invested in stocks, but as a child gets closer to needing those funds, the risk taken in the account needs to be pulled back and more invested in bonds instead of stocks,” Carolyn McClanahan, a certified financial planner and founder of Life Planning Partners Inc, said. “We generally use age-based portfolios that gradually become more conservative the closer a child gets to entering college.”
But in this year’s down bond market — which is mirroring losses in stocks — that strategy doesn’t help. The alternative is to switch to cash, instead, according to McClanahan.
“Of course you lose the opportunity for growth,” McClanahan said. “But you also lose the risk of loss.”
Another option is to transfer your fund to a state that has a stable fund, Mahaney said.
“We can't afford losses as those college expenses come due, so families should consider shifting to a stable value fund when their child is in high school,” Mahaney said. “Not all states offer a stable value fund, but a 529 owner can transfer from one 529 plan to a state that offers it, like Colorado. With a stable value fund, the principal and interest is guaranteed and cannot lose value.”
Consider a Parent Plus loan if your 529 plan has taken a hit
Those strategies may be too late for parents who have to write a check now for their kid’s college expenses. Instead of withdrawing from a down 529 plan, Mahaney said some parents may want to consider borrowing the money using a Parent Plus loan to “buy time” so their 529 plan’s value recovers.
“There is risk in this approach in terms of having to pay interest,” Mahaney said. “But if history is a guide, we know stock values typically bounce back eventually and bond funds should do so as well in a rising interest-rate environment as maturing bonds can be reinvested at higher yields.”
If you do take out a Parent Plus loan, remember you can use your 529 plans to repay these college loans, giving you more than four years for your accounts to recover, Mahaney said.
Even though today’s market is not optimal, there are still many benefits to 529 plans.
“529 plans are great vehicles to use to save and invest for college, but the challenge is that we are exposed to risk in 529 plans in a similar way to how that risk can impact our retirement income plans,” Mahaney said. “I strongly believe that stable value funds paying 1.5%-2% on your pile of money at the end of the college savings race have an important role to play. Why take the chance and create worry when it is unneeded?”
Ronda is a personal finance senior reporter for Yahoo Money and attorney with experience in law, insurance, education, and government. Follow her on Twitter @writesronda