HomePersonal FinanceCollege

Coping With Bad College-Savings Results

mainstreet

By Jeff Brown

You say you�re unhappy with your 529 college savings plan? You�re not alone.

Many investors are disgusted with the big losses their plans suffered, and industry data shows substantially less money flowing into these plans this year compared to two or three years ago.

But before you throw in the towel and move out of 529s altogether, take a reality check. Your 529 plan may not be as bad as you think, and the alternative may be no better.

The chief benefit is still there. That�s the tax-free treatment of investment gains withdrawn for higher-education expenses. Granted, that�s not too valuable if your account has losses rather than gains, especially if your child will start college in the next few years.

But if you�ve had the account for a number of years, or have five years or more before college expenses begin, investment gains could still be big enough to make tax-free treatment valuable.

Of course, if you have suffered losses, pulling your money out could be painless. You must pay tax and a 10% penalty on withdrawals that are not used for college or graduate school, but tax and penalty apply only to investment gains, not your original deposit.

Among the most disgusted groups of 529 investors are those who selected age-based funds that emphasize stocks when the child is young and gradually shift to bonds as the college years get close.

The brokerages and mutual fund firms that provide 529s can be faulted for not explaining more clearly that age-based funds do contain plenty of risk. Even if the target date is very close, many of these funds keep some assets in stocks, hoping to provide inflation-beating growth in case the funds aren�t tapped until the tail end of the child�s college or graduate school years. Some age-based funds went overboard, keeping more than half the assets in stocks even after the college starting date had arrived.

But the fact is that the market meltdown of 2008 was extraordinary, and torpedoed many types of bonds as well as stocks. About the only way to avoid losses would have been to invest in cash, and that would have ensured that an account�s growth would not keep pace with rising college costs, let alone exceed them.

The typical age-based 529 did no worse than the market as a whole.

Still, an unhappy investor has every right to explore alternatives. The first is to shift the account to a different 529, with the same firm or another. Your plan provider can tell you how.

Another option is to get out of the age-based fund and put some of the money into a stock-only 529 and the rest into one that specializes in bonds. That will give you more control over risks, though you�ll have to change the asset mix yourself as the child gets older.

Pulling out of your 529 in favor of a taxable investment could backfire if you have to pay tax and penalty on the withdrawal and then face tax on investment gains in the new account.

If you do look for new funds, keep a close eye on fees. The less you pay the better. Some 529s use index-style funds with rock-bottom fees. Morningstar Inc. (Stock Quote: MORN) has produced a list of funds it considers best. Also look at this list of top-performing plans compiled by SavingforCollege.com, a site full of useful 529 information. Note that Charles Schwab (Stock Quote: SCHW) is at or near the top in one-, three- and five-year categories.

For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.