Delay use of 529 plan



Dear Joe, My son starts college next year. His 529 is worth less than the amount of money we contributed over the last six or so years. Is Congress looking at this scenario (as they have with retirement distributions)? -- Martha Nelson


Dear Martha,

In the aftermath of the 2008 stock market collapse, Congress passed a law waiving the requirement, for 2009 only, that individuals age 70½ and over take minimum annual distributions from their IRAs, 401(k)s and other qualified retirement accounts. Our elected representatives in Washington felt it would be wrong to force retirees to liquidate their investments while market values are down so substantially.

However, Congress has not made any such changes affecting 529 plans. Unlike qualified retirement accounts, 529 plans are not subject to required minimum distributions. You can continue to keep your 529 account intact for as long as you have a living individual named as beneficiary. The fact that you can change beneficiaries to another qualified family member, including descendents, at any time means that your account can stay invested for many, many years without being distributed.

However, in your particular situation, the money in your 529 account may be needed fairly soon to pay your son's college bills. The tax-free feature of 529 plans will be of no use to you if your account has no net earnings. You may want to delay using your 529 plan for as long as possible to give it a chance to rebound in value.

Perhaps you can target the use of the 529 money to your son's junior and senior years in college and take loans or use other money in the meantime. Just make sure you do not wait so long that the remaining college expenses are less than your 529 account balance. To be tax-free, your 529 distributions should not exceed the amount of qualified expenses paid in the same year.

Another option is for you to liquidate the account and distribute the entire balance back to yourself. By doing so, you are able to claim the loss as a miscellaneous, itemized deduction on your federal tax return. You'll receive a tax benefit to the extent your total miscellaneous itemized deductions exceed 2 percent of your adjusted gross income and provided you itemize your deductions and do not fall into the alternative minimum tax. Because there are no earnings, there is no 10 percent penalty to worry about, regardless of how you spend the proceeds. You should speak with your tax professional before making this decision, and be sure to ask about any potential state income tax consequences.

While Congress has made no changes affecting 529 plans in the current market environment, the Internal Revenue Service has offered a little more flexibility. For 2009 only, you will be permitted to make up to two investment changes in your 529 account. Previously, you were restricted to one change in any calendar year, although you can change investments any time you change beneficiaries.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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