6 strategies for 529 plan withdrawals

http://www.savingforcollege.com/articles/20090327-529-plan-withdraw-strategy

Tuition bills are never welcome, but this year they are likely to provoke more anxiety than usual.

With the tumultuous economy, unemployment skyrocketing and home values sinking, funding your child's college education requires drawing on a full range of financial options.

College costs have risen at a rate higher than inflation during the past 10 years, and the 2009-10 school year will likely be no different. The 2008-09 average for tuition, fees, and room and board for four-year public colleges was $14,333 and $34,132 for four-year private colleges, according to the College Board.

Stressed by falling revenue, public colleges are increasing tuition, with New York, Florida, Alabama and Maine among those announcing double-digit tuition increases for the 2009-10 school year. Endowments at private schools are shrinking, which may also cause higher-than-average tuition increases.

If costs rise 5 percent — a slightly higher rate than they have during the past 10 years — average costs at four-year public colleges would be $15,049, a $716 increase, and at private schools, $35,838, a $1,706 increase.

While there is no one-size-fits-all answer for each family grappling with tuition bills, there are some steps you can take, which include making strategic withdrawals from your child's 529 plan, tapping savings or home equity, making use of government loan programs and requesting additional financial aid from your child's college.

Above all, stay calm. "The first thing to do is not to worry or panic," says Nicholas Yrizarry, CEO of Nicholas Yrizarry and Associates, a financial advisory firm in Reston, Va.

1. Apply for financial aid

Even if you don't believe your child qualifies for financial aid, apply for it. Your financial circumstances may have changed enough from previous years that you will qualify for some type of aid, even if it's in the form of loans. Issues such as job loss or a pay cut, a reduction in your home's value or savings eroded by a falling stock market can all affect your financial aid award.

The deadline for filing the Free Application for Federal Student Aid, or FAFSA, is June 30, 2009 for the 2009-10 school year, although individual colleges frequently impose earlier deadlines. Many private colleges and scholarship programs also require submission of the College Board's Profile.

File your income taxes as early as possible, as most colleges will want to see your federal return along with your FAFSA and/or your College Board's Profile.

2. Examine dedicated college-funding accounts

If you've been avoiding taking out your statements for your 529, your Uniform Gift to Minors Act account and Coverdell Savings Account, you may be pleasantly surprised — at least in terms of the 529 statements. If you invested your savings in an age-based plan and your child is college-age or near college-age, most of your savings already have been automatically shifted into more conservative options, such as bond or money market funds, which haven't been impacted as much by the current economic downturn.

"It's likely that if you have an age-based account in your 529 plan that your account may be even or just slightly down for 2008," says Mark Bodnar, Certified Financial Planner, or CFP, of AXA Advisors in Cincinnati. "That's because the credit crisis did have some impact on bond funds." However, if you selected a more aggressive strategy either inside or outside a 529 plan in the form of single-stock funds or a group of stock funds, your investment accounts may have taken a big hit since equity averages are down 50 percent on average from market highs.

Add up all the funds you have in dedicated college accounts for your college student so you first have a big-picture view of the funding available. To preserve as much money as possible for the entire four years, many parents divide their account balances by four, one for each year of college.

But this year a different strategy may make sense depending on your financial situation. If you've experienced a significant reduction in income, it might be wise to spend more out of your college savings accounts this year in the hope that your child may qualify for more financial aid in the future.

Many colleges reduce your child's financial aid award dollar for dollar based on how much 529 or other college savings account funds you have, so if you have fewer dollars in the future, your child will qualify for more aid. Spending less out of your 529 and other college accounts in the hope of getting more aid this year generally doesn't work because colleges can see how much you have and expect you to spend at least one-fourth of it each year.

3. Don't forget about Uncle Sam

Because Section 529 plans and other dedicated college savings vehicles are tax-advantaged accounts, you have to consider taxes when making withdrawal decisions. With the market down so much, fewer accounts are posting gains, making tax issues less vexing for the 2008 tax year than in previous years, says Joe Hurley, CPA and founder of SavingforCollege.com.

If your account balance is down significantly, you can postpone using the 529 money until later in your child's college career, such as junior or senior year, to give the account time to recover. "It could make sense to delay using the 529 money and paying for as much as you can out of other savings or current earnings so that any gains you do have later are available tax-free," Hurley says.

A negative 529 earnings situation allows you to remove funds from the account without paying a penalty. "The funds do not have to be used for college until you are in a net gain position," Hurley says. In addition, you can deduct any realized losses — those incurred when you sell 529 assets — as a miscellaneous itemized deduction if you itemize on your federal tax return and have enough deductions to meet the 2 percent floor.

However, if you have previous gains you have locked in by using an age-based investment plan that has transferred your savings into bond or money market funds, you must use those for qualified college costs to avoid tax penalties. "Make sure you understand the simple truth about College 529 Savings Plans: They can and will be taxed if the proper exit strategy is not in place, says Marc Hill, a certified college planning specialist at Reduce My College Costs, in Littleton, Colo.

"The maximum amount that can be taken out of your 529 savings plan to pay for eligible charges for the year in question is determined by calculating your Adjusted Qualified Education Expenses," he says. This value sets your withdrawal ceiling, and any amount beyond this may be subject to taxes and additional penalties."

Expenses paid out of a 529 account must meet a test as qualified expenses as defined by the IRS. Such costs include tuition, room, board, fees, books, supplies and equipment for students attending an eligible higher education institution. Eligible schools are colleges, universities, vocational schools and other institutions that are eligible to participate in student aid programs overseen by the U.S. Department of Education.

4. Consider transferring 529 assets in negative territory

If your college-age child's 529 or other college savings account has experienced sharp investment declines, it may make sense to transfer those assets to a younger sibling. Scott Sprinkle, a CPA and personal financial specialist with Sprinkle and Associates LLC, in Littleton, Colo., says: "Let the younger siblings take the risk with the more aggressive assets because they have more time to recover than a college-age child." For more information on this strategy, see "Can beneficiary swap salvage sinking 529 plan?".

Using this strategy, you would need to spend money out of other savings or current income or borrow funds to pay for your college-age child's tuition, room and board, but you wouldn't have to tap beaten-down investment funds.

5. Analyze other funding options

If you're like most parents, dedicated college savings and current income won't meet all your college-related expenses. Other options include tapping savings, investments, home equity lines of credit and other loan sources.

Prior to the crash in home values, tapping home equity was a popular strategy for the parents of college-age students. It is still a viable option for parents with a decent amount of equity in their homes who still have access to lines of credit, says Bodnar. "It's low-interest-rate money — many lines of credit are running at 4 percent interest these days — and it is tax deductible so it is really cheap money," he says. "In addition, most lines of credit only require you to pay the interest initially, so the payments are low."

However, many financial institutions are cutting back on lines of credit, especially in markets where home prices are falling, so it's best not to count too heavily on a home equity line of credit to finance a college education.

If you have investments in taxable accounts that are worth less than you paid for them, it may make sense to cash those out, take the tax loss and spend at least some of that money on college expenses. You could also earmark some funds socked away in bank savings accounts or in money market accounts.

Another option: federal student loans. Undergraduates and graduate students can apply for money from the Stafford Loan Program and may qualify for a subsidized loan, which means the interest on the loan won't accrue while your child is in college.

PLUS loans are an option for parents as well, says Yrizarry. While students take out Stafford loans, PLUS loans are exclusively for parents. The interest rate is fixed at 7.9 percent for PLUS loans and limits are much higher than Stafford loans.

6. Try for more financial aid

This is a popular option if your financial circumstances have changed. If you've lost your job or have had a major financial setback, call the school's financial aid office and ask for mid-year help.

"The way to relieve the stress associated with college funding is to realize that colleges are cognizant of the bad economy and they are, in many cases, willing to renegotiate financial aid packages if the parent isn't able to meet their obligation to pay the bill on time," says Yrizarry.

If your child is a high school senior and has been accepted by several colleges with differing financial aid packages, you can try to negotiate with the college your child likes best and lobby for more aid, says Hurley.

"It makes sense to try to get more money," he says. "Schools try to gauge how much risk they run in losing a child based on finances. If they think your child is a lock at their school, they might not give you much.

When approaching the school, try to meet with officials in person — it's much harder for them to turn you down if you are sitting across a desk from them than if you are calling or sending an e-mail.

Posted March 27, 2009