IRS is allowing a 2nd switch on 529 plans

The Baltimore Sun

Many families could only stand by and watch as their 529 college savings accounts plunged along with the stock market last year.

Their hands were tied by an Internal Revenue Service rule that allows account holders to change investments only once a year, or when they switch the account beneficiary.

So, if they had made a change in their account early in the year - often the time families make adjustments - they were unable to act again as stocks tanked in the fall.

But the IRS, which has been giving taxpayers leeway in other areas because of the severe recession, is doing the same for 529 college savings plans. For this year only, the IRS will allow you to switch your investments twice.

"In the first part of the year, people made responsible decisions to change their investments from one option to another. No one would have predicted what happened in the stock market in the latter half of the year," says Joan Marshall, executive director of the College Savings Plans of Maryland. "It is very restrictive ... to allow only one change per year."

It's up to the plans whether to permit twice-a-year changes, but they're expected to do so.

Of course, just because you're allowed more flexibility to make investment changes this year doesn't mean you should.

If you move from stocks to bonds because you lost money last year, you would be locking in those losses and could miss out if the equity market rebounds.

"Flexibility is a double-edged sword when the market is in turmoil," says Greg Brown, a mutual fund analyst with Morningstar Inc. "Sometimes the best thing is to do nothing."

Whether you should make changes will depend largely on your child's age.

If you have a younger child, you have the time to ride the ups and downs of a fairly aggressive stock portfolio. And stocks still manage to provide the best returns over the long haul.

The difficult choice will be for families whose children are a year or two from college. Do you stay put with your investments, or not?

The first step is to dig into the details of what you're invested in now. The majority of 529 money is invested in age-based portfolios, where the mix of stocks and bonds becomes more conservative as a child approaches college.

But what is conservative can differ widely from plan to plan. You could be in a very conservative portfolio. Or, as you might have discovered last year, your portfolio had far more exposure to the volatile stock market than you thought.

For instance, Louisiana's and Florida's plans don't invest in stocks for portfolios designed for children 16 and older, according to a study of age-based accounts last year by But it is not uncommon for portfolios for those 17 and older to have 20 percent or 30 percent of their money tied up in stocks, says Joseph Hurley, founder of

In Maryland's plan, the portfolio designed for high school seniors is made up of 24 percent stocks, while the portfolio for college students has 20 percent in equities.

All but one of the investments in the Maryland College Investment Plan, managed by Baltimore's T. Rowe Price Associates, posted losses last year ranging from 8.35 percent to 40.39 percent. The short-term bond portfolio gained 0.89 percent.

Rockville financial planner Christopher Brown says he advises clients, no matter how young their children, to choose an investment portfolio with at least some bonds for ballast. When the child is three years from college, the family should switch to a fixed-income portfolio, he says.

If your child is headed to college soon and you took a hefty loss last year with stocks, you face some difficult choices.

You could postpone taking money out of the plan and instead use other resources to pay for college in the first two years, Brown says. That could give your portfolio time to recover and pay for the junior and senior years, he says. But there is the risk that stocks won't recover by then.

Or, if you don't want to lock in losses by switching investments just yet, you can always direct new contributions into a short-term bond fund or other conservative option, says Maryland's Marshall. If your 529 account balance is worth less than all your contributions, though, you might be tempted to throw in the towel and liquidate the account. You wouldn't have to pay any taxes or penalties on the earnings because you don't have any.

And, if you're not subject to the alternative minimum tax, you could get a tax deduction for your losses. It would be included under the miscellaneous deduction, meaning you would be able to deduct losses - plus certain other expenses - that exceed 2 percent of your adjusted gross income, Hurley says.

Beware, Maryland and some other states that allow residents to deduct contributions would recapture those deductions on the next state income tax return. Plus, by liquidating you could miss out on a market recovery.

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