Market losses hit 529 college savings accounts

Like most other investors, many parents are seeing big hits to their children's 529 plan balances this year. But unlike other types of accounts, 529 plans restrict changes to the investment mix to once every 12 months. So if you're a parent who made changes earlier this year as the market collapsed, you are now forced to watch your account go down further without the ability to make additional changes. But that doesn't mean your hands are tied - there are other ways you can protect your college nest egg.

529 Plans are state-run accounts that allows investment of after-tax dollars specifically for higher education. The money grows tax-deferred, and if withdrawn for qualified college expenses, is not taxed. These types of accounts have grown in popularity since their inception in 1996 and held more than $110 billion in assets at the end of the second quarter of 2008. Each plan offers several investment choices; all offer age-based portfolios that change the mix of stocks, bonds and cash as the child ages and gets closer to college age. The asset mix can vary significantly among plans. South Carolina's mix for a 14-year-old includes 47 percent in bonds or fixed-rate investments, while California's allocation for the same age is 63 percent. This can translate into very different performance returns in good and bad markets. All plans also offer other investment choices with fixed investment mixes that don't change with age.

One common rule among all 529 plans is that changes to the allocation mix are allowed only once in a 12 month period. This has been particularly hard on parents during 2008 as markets have swooned. So what can you do?

First of all if the intended benefiary - the student - is young enough it's probably wise to leave a healthy amount in stocks regardless of market performance this year. If your child has 8 years or more before college having 50% or more in stocks is still your best bet to grow your money at a rate faster than college cost increases. So you might want to leave your account as-is, or even add money and invest in equities to take advantage of low prices.

For older children you don't have as much time to make up for losses. If you've already made your yearly allocation change don't lose heart, there are several other things you can do. You can move the account to another state's plan, which will allow you to choose a new asset mix, but only one rollover is allowed in a 12-month period. You can also change the beneficiary of your existing plan, which frees up the account to allow an investment change. There are no restrictions on how often you can change beneficiaries so if you have two children you can switch the account between them as often as you like, making investment changes at the same time. (Note - intergenerational changes can trigger gift-tax problems.)

If your 529 plan is not large enough to pay for 4 years of college consider postponing use of the account until the later college years. This will give you a longer time to recoup market losses.

Finally you can add money to the account and direct the new money into one of the fixed investment options, such as a 100 percent stock portfolio or a money market fund, to bring the overall asset mix to your target. (For an added tax benefit consider generating this new money by selling investments in your taxable account that have losses. You'll get to take the loss on your tax return.)

Whether you make changes or not 529 plans are still a good choice for education planning. Don't let the current market get in the way of a great tax-free way to fund college.