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How to Bail Out a Sinking 529 College Plan

Stocks in this article: MSFT

Don't wait so long to tap the 529 funds that any remaining tuition expenses are less than the account balance. That would leave you with a significant tax penalty when liquidating what's left.

Switch beneficiaries: You're allowed to change a 529 plan's designated beneficiary, so it might be best to save the money for a child still many years from college. That would give the plan assets plenty of time to recoup last year's losses.

Switching beneficiaries makes sense in other situations, too: If you end up with leftover funds in a 529 after paying for a child's education, changing the beneficiary will allow you to avoid the tax consequences that would come with cashing out the account.

The IRS allows for considerable flexibility in choosing a new beneficiary. Select any family member of the original beneficiary -- a first cousin, a step-sibling or even your child's niece or nephew.

Save the funds in the 529 for your children's future children. Consult a financial adviser if you're interested in going this route, since shifting the plan between generations could trigger gift taxes and the generation-skipping transfer tax.

Liquidate the account to harvest the loss: If you've got less money in the plan than originally invested, you can liquidate your plan and claim the loss as a miscellaneous itemized deduction on your tax return. Keep in mind, though, that you'll only get a tax benefit to the extent that the total miscellaneous itemized deductions exceed 2% of adjusted gross income.

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