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Don’t Panic: What to Do with College Savings in a Volatile Market

Written by Kathryn Flynn | August 6, 2024

Investors in 529 plans may be concerned about recent stock market volatility. Families may start to panic and make moves detrimental to their college savings. Before making any changes to your 529 plan investments during a stock market downturn, here are some things to consider.

Age-based investment portfolios were designed to balance risk and return

529 plan investment portfolios generally offer age-based and static asset allocations. With an age-based option, the asset allocation is designed to automatically shift away from stocks and move toward more conservative investments as the child gets closer to college.

Investors can rely on the 529 plan’s investment manager to manage risk based on the child’s age. Families with older children have less exposure to market volatility than those with younger children, who have more time to recover from the losses that come with higher risk.

During a market downturn, 529 plan investors in static portfolios should make sure their asset allocations are appropriate for their child’s age and the level of risk they are comfortable with. If significant time has passed since the last investment change and the child is approaching college age, it may be time to shift toward safer assets, regardless of market activity.

Dollar-cost averaging benefits long-term 529 plan investors

Families who continue to make regular automatic contributions to a 529 plan over an extended period of time will benefit from dollar-cost averaging. With dollar-cost averaging, a fixed amount is invested at pre-determined intervals.

When markets are up and share prices are higher, investors purchase fewer shares per dollar invested, and when markets are down and share prices are lower, investors can purchase more shares.

Dollar-cost averaging has the same effect regardless of whether markets go up or down. If a family makes regular, automatic contributions to a 529 plan for 18 years, the average cost per share will represent both a bull market’s premium prices and a bear market’s low prices. 

Cashing out means locking in losses and missing out on the recovery

The stock market dropped by as much as 40% in 2008 and continued to fall until it hit rock bottom in March 2009. Many investors panicked and pulled their money from the stock market, essentially locking in their losses.

However, investors who remained calm and continued to invest reaped the benefits of the market’s steady improvement through January 2018. According to a study by Fidelity, Baby Boomers who continued making contributions to their 401(k) plans during the Great Recession tripled their account balances from 2007-2017.

Depending on your time horizon until college, staying the course and keeping your funds invested in a 529 plan during a down market may make sense. 

Increasing 529 plan contributions will compensate for losses

Instead of liquidating 529 plan investments during a bear market, families should consider increasing 529 plan contributions to compensate for any losses. When markets are down, shares can be purchased “on sale,” and prices will likely rise again, especially for parents with a longer time horizon until college. 

IRS rules for liquidating a 529 plan

Prior to 2018, some investors who lost money from a 529 plan investment could claim the loss on their income tax return. To claim the loss, the 529 plan account had to be completely liquidated, and any non-qualified distributions would be subject to income tax and a 10% penalty on the earnings portion of the distribution. The total amount of itemized deductions had to be greater than 2% of the taxpayer’s adjusted gross income.

However, the Tax Cuts and Jobs Act of 2017 suspended write-offs for miscellaneous itemized deductions for tax years 2018-2025, including losses from liquidated 529 plans, traditional IRAs, and Roth IRAs.

Investors with a poor-performing 529 plan may be better off rolling the funds into a different 529 plan to avoid paying taxes and penalties on a non-qualified distribution. Families looking to mitigate investment risk may also consider moving some or all of their college savings into a prepaid tuition plan. 529 plan account owners are allowed one tax-free rollover per beneficiary in a 12-month period.

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About the author

Kathryn is a former Editor-in-Chief at Savingforcollege.com and is a subject matter expert on 529 plans. Since joining the team in 2014, she has created a variety of content to help families and financial professionals understand the best ways to save for education. She has been quoted in The Wall Street Journal, the New York Times, Fortune and other well-known media outlets. As a parent, Kathryn practices what she preaches when it comes to saving for college. She has a 529 plan for each of her three children and actively looks for ways to bring down their future college costs.

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