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COLLEGE SAVINGS 101

Time to change age-based 529 plan?

Posted: 2009-04-03 - Amy E. Buttell is a freelance writer based in Pennsylvania

by Amy E. Buttell

If recent market turmoil has knocked a big hole in your Section 529 college savings plan, it's time for you to assess carefully the risk profile of any age-based plan you have funds in, and strongly consider switching to a different plan.

This year, switching plans is easier than past years. Until recently, 529 investment changes or rollovers to a new plan were limited to once a year. Incited by the rocky market environment, the IRS has modified 529 investment rules for 2009, allowing you to change or rollover twice.

Age-based plans are popular, with 75 percent of 529 plans offering such options, according to Wilshire Associates. Such plans allocate plan assets more aggressively for younger 529 account beneficiaries and then switch to more conservative investments as the beneficiary gets closer to college age. For all their simplicity, there are wide variations in the mutual funds that make up each age-based fund and the timing at which those funds are moved into more conservative options.

For parents invested in age-based 529 plans, consider whether your account has suffered losses and how much and how much time you have before your child or children will attend college. For parents of young children, it pays to assess carefully the risk profile of any age-based plan you have funds in, and strongly consider switching to a different plan if you aren't satisfied with what you have now.

If you've lost money but your child is more than six years away from attending college, you can probably ride out the storm, as the market is likely to cycle upward in the meantime. However, if you've lost money and your child is within two, three or four years of attending college, you're in a bind. It's probably too late to make up the ground that you've lost, but you might be able to stem further losses by switching to another investment option.

"One of the key elements for anyone close to a specific investment goal -- whether that goal is college or retirement -- is the sequence of returns," says John McAvoy, CFP, of Waterstone Retirement Services in Canton, Mass. "You can have 10 years of tremendous growth, and as we've all seen in the past year, that growth can get wiped out. That nest egg is gone. When you have these age-based accounts, it is absolutely critical that as you get close to using that money it be very, very safe, because you don't have time to make up the difference."

Understanding risk

When you invest in any target-date investment -- whether a college savings plan or retirement plan option -- it's vital to understand the risks involved. Because you are investing for a specific goal that will occur at a specific time, you don't necessarily have the flexibility to change that target date to account for problems you may encounter along the way, such as a declining stock market.

"The current market environment gives parents a real life reality check on what risk tolerance really means," says Keith Newcomb, a financial adviser with Full Life Financial LLC in Nashville, Tenn. "There are two kinds of risk tolerance -- the financial capacity to withstand risk and the emotional capacity to withstand risk. High risk does not always equal high returns and low risk is not always equal to less return."

Because college savings are specifically targeted to a certain date, it's a very inflexible goal, even more so than retirement. "College savings is very much time-limited and it is very specific," Newcomb says. "Most kids don't want to put college on hold -- working another couple of years and putting off retirement is very different than waiting a couple of years to go to college."

Types of portfolios offered

Administrators and investment managers of 529 plans have very different takes on what constitutes aggressive, moderate and conservative age-based accounts. They also vary on the point at which investments should move from one stage to another. Both could affect profoundly how much money you will have to send your child to college. Here are some examples:

Aggressive: An aggressive age-based investment plan likely includes a significant percentage of stock mutual funds, even after your child has entered college. While this obviously has the potential to increase the funds you have available to pay for college in later years when the market is going up, it also has the potential to further erode what you have saved if the market continues to decline. Generally experts believe that investments for college-age students should be in a risk-free vehicle such as a FDIC-insured savings account or money market fund.

Moderate: Moderate plans generally include a bond or real estate component -- or both -- from when your child is very young, and the percentage of assets invested in stocks decreases faster than in an aggressive portfolio. These plans may have a very small percentage of invested assets in stocks even when the student reaches college age, but most focus investments at this point in cash -- such as an FDIC insured account or a money market fund -- bonds or real estate.

Conservative: In a conservative portfolio, you potentially miss some potential for appreciation that portfolios with higher percentages of stock offer, but you also have less chance of losing money you've invested. These portfolios are likely to have hefty concentrations of bonds even when your child is quite young and are likely to transition totally to bonds, cash or real estate in the early teen years.

Gather data

If you're considering making changes in your 529 investment plan options, the first step to take is figure out where you stand today. Go to your state plan's Web site or pull out your most recent statements and determine:

  • Your current investment strategy: The percentage and dollar amounts you have invested in different mutual funds as well as what fund company is investing those amounts.
  • Future investment strategy: Exactly how often and when your investment strategy will change and exactly what such a switch involves.
  • Current loss/gain: Get some perspective on how the particular strategy you are enrolled in has performed, obtain information either on the Web site or from your statement as to how much you have invested, how much your accounts are currently worth, and the difference.
  • Performance: Check out the investment strategy's performance during the past one, three and five-year periods.

If you can't get this information from the Web site or your statements or don't understand the information provided, pick up the phone and call the customer service number listed on the site or on your statements. Write down your questions beforehand and don't hang up until you have answers that make sense.

The second step to take before making a decision about switching investments is to recalculate how much money you are likely to need for college expenses for your child or children and how much of that unfunded liability you can meet, says Newcomb. Check out our World's Simplest College Cost Calculator. This will give you an idea of what it will cost to send your child to college four years. You can look up average costs for private and public colleges at the College Board Web site.

Third, use a federal student aid calculator to get an idea of what the government and state colleges expect you to spend on your child's education. This amount is known as the "expected family contribution," or EFC, and is a fixed amount that you are expected to spend based on your income, savings, debts and other obligations.

"A lot of people's assets and incomes have changed recently, and those may radically alter how much you are expected to contribute," says Newcomb. "So take a dry run through the FAFSA and see what your expected family contribution looks like."

Making a change

Armed with information about where your current investments and balances are, as well as data about college costs and what your expected family contribution, you are now in a position to decide whether you need to make a change. Here's an overview of issues to consider depending on how old your child is:

  • Under age 8: If your kids are more than 10 years out from attending college, you have a lot of flexibility. Even if your accounts have lost money, you have enough time to make up those losses. Still, you want to be comfortable with your investment options going forward, so you need to take a close look at your risk tolerance. Decide if you have the fortitude to see a couple more years of steep losses on your statements, or if you want to tone down the aggressiveness of your portfolio, at least to the point at which your investments are somewhat conservative two years or so before they start college.

    Even if you position your portfolio in a less aggressive manner, you still likely want to have some exposure to stocks, because it is likely that the market will turn around before your child goes to college. "I would say that there is a higher probability that you will do well in the market over the next 10 years," says McAvoy.

  • Age 8 to 13: If your kid is less than 10 years but more than five years away from college, you aren't in as good a position as those with younger kids, but you still have time to make adjustments and make up for any money you might have lost in the market. Again, you may want to tweak your age-based investment plan so that you aren't taking much risk right before your child enters college. Many plans convert investments into all or mostly all bonds or cash when the child turns 16, which would protect you from losses right before college begins.

  • Age 13 and above: If your child's 529 portfolio took a painful hit, you don't have much time to make that money up and you may not be able to afford to do so. In this case, it's even more important for you to run the expected family contribution numbers in the FAFSA calculator and seriously think about what type of college your child is likely to attend.

Too many parents set their sights on Ivy League schools with four-year tuition, room and board exceeding $200,000, which is a mistake, says Newcomb. "It really depends a lot on the child," he continues. "It depends on the chosen field of endeavor. There are great programs at the less expensive schools." When your child is applying to colleges, make sure at least one or two choices are safety schools from the viewpoint of affordability as well as admission. Look at not only large state universities, but also smaller state-sponsored schools and community colleges that may offer bargain rates, even compared to large state schools.

If you've decided to make a change, do it now. If you delay, it is less likely you will follow through on your decision, which could negatively affect how much you have to pay college expenses in the future. Call your state's plan and request an investment change form, or download one from their Web site. Then don't forget to fill it out and send it in.

Posted April 3, 2009

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