If you've set aside money in a 529 plan to pay for your child's future tuition, your account likely has lost a bundle in the past year. That's not a big deal if your kid is still in diapers, but if he is college-bound soon, a sinking 529 could pose serious problems. How can you salvage what's left of college savings so Junior can get that job at Microsoft ( MSFT) someday? Consider the following options. Make sure the plan isn't too aggressive: Many 529 investment options are designed to become more conservative as your child gets older. If you have one of these target-date funds, or if your teenager's 529 is largely invested in certificates of deposit or money market funds, simply stay the course. Otherwise, consider switching to more conservative investments within your plan. It might be appropriate to have most or all of your money in CDs or money market funds if your child is headed to college soon. The IRS typically allows you to change your plan once a year without penalties. Due to the economic crisis, you may change your plan twice penalty-free in 2009. Give the account some time to recover: If possible, plan on using the 529 to pay for your child's third or fourth year of college, or even graduate studies. This strategy will give the account a chance to recover what it's lost. In the meantime, take out a loan to pay for the first few years of schooling, and be sure to pursue other potential financial aid opportunities such as grants or scholarships.
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.
Liquidating the account means turning paper losses into real losses. What's more, when the market rebounds after a bear market, most of the gains tend to come in the first few months of the recovery. So by cashing out, you risk the chance of missing the ride back up. Don't panic: Don't make sudden changes to a 529 just because it's lost money. If your account has an appropriate allocation strategy for your situation, you likely are best off continuing to contribute on a regular schedule and waiting for things to turn around.