Don’t Panic: What to Do with College Savings in a Volatile Market
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. Here are some things to consider before making any changes to your 529 plan investments during a stock market downturn.
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 are able to 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 the premium prices of a bull market and the low prices of a bear market.
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.
But, investors who remained calm and continued to invest reaped the benefits of the markets 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, it may make sense to stay the course and keep your funds invested in a 529 plan during a down market.
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 were able to 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 taxpayers adjusted gross income.
However, the Tax Cuts and Jobs Act of 2017 suspended write-offs for miscellaneous itemized deductions for tax years 2018-2025, which includes 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 529 plan beneficiary in a 12-month period.
A good place to start