Protect your 529 plan against major life events

http://www.savingforcollege.com/articles/20101008-protect-your-529-plan-against-major-life-events

In theory, saving for college should be easy. You transfer money regularly to a 529 plan and watch the account balance grow. But we all know how life can get in the way. A job change or loss, a new baby, a divorce, or death can decimate even the best-laid savings plans, says Kara Harmon, a CPA and Certified Financial Planner with the Moneta Group LLC in Clayton, Mo.

"These are events that people don't necessarily plan on," she says. "But through the course of smart financial planning, you can deal with these events more effectively."

To help mitigate the effects of a major life change on your 529 plan, consider making these tweaks to your financial life. The strategies may not prepare you for the emotions of a major change, but they can help you tackle the economic side of the equation.

Life event: Birth of a new child.

Potential issues: Splitting up funding for more than one child is tricky when there are different time lines and potential costs.

How to protect yourself: Set up savings in advance.

"When you have a baby, setting up a 529 plan isn't going to be the first thing on your mind," says Ken Nussbaum, a CPA with K. Nussbaum & Associates LLC in Richmond, Vt.

"Set the money aside in a savings account or put extra in the first child's account, which you can switch over as soon as you have a Social Security number for your new baby," he says.

Life event: Job loss.

Potential issues: Raid your 529 plan to pay for expenses while you're unemployed, and you'll face a trifecta of loss. You'll lose the money from your account, incur a 10 percent penalty on nonqualified distributions and potentially have to pay back any state tax breaks you received when you deposited the money, says Nussbaum.

How to protect yourself: Go back to basics and make sure you have a cash reserve before funding a 529 plan, says Harmon.

"Having six months worth of cash is very important," she says. "You're better off drawing from a savings account than going to a 529 account for that money."

Life event: Divorce.

Potential issues: An unscrupulous ex drains an account without your knowledge or approval.

How to protect yourself: While you may be able to work out a plan in the divorce decree, you still have options before the divorce is final, says Mary McConnell, director of college savings products for Charles Schwab in San Francisco.

"You can always speak to one of your parents -- a grandparent -- about opening an account on behalf of your child. The assets belong to the account owners, which would remove the funds from either spouse's holdings," McConnell says.

Life event: A major move.

Potential issues: Depending on your 529 plan and your residence, you may lose state tax credits or deductions.

How to protect yourself: The good news is that 529 plans are quite portable, Nussbaum says. "A move doesn't have to have any impact at all," he says, noting that parents can keep -- and contribute to -- any account they wish, no matter where they live.

If you're worried about state tax breaks, you can either set up a new account in the state of your current residence, assuming the state offers a credit or deduction. Or, you can roll over the old account to the new 529 plan and continue to contribute.

Life event: A new job.

Potential issues: Automated payments to a 529 plan from your paycheck occur through your employer.

How to protect yourself: Don't delay. "You can complete new paperwork with the new employer right away to have money moved into a 529 account through your new paycheck," says McConnell.

And once you've automated withdrawals, you probably won't notice that it's gone. "If you determine you can't continue, it's very easy to stop," McConnell says.

Life event: Death of a parent.

Potential issues: The dramatic and emotional loss could be compounded by a financial loss that requires the living parent to use 529 plan funds to pay for expenses or to limit future contributions.

How to protect yourself: Get insured. A term life insurance policy can help with financial needs after such a loss, says Harmon.

"If you have enough life insurance, you may be able to pre-fund a college education (after receiving an insurance payout)," she says. "If paying for your child's education is a top priority for you, it's worth looking into."

A 529 plan can be one of your most significant investments, so it pays to think ahead, says Nussbaum. "You always want to think about the consequences first and then act based on your knowledge," he says. "It's important to be proactive."

Posted October 8, 2010