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Don’t abandon your 529 plan in turbulent markets

May 08, 2020 | RBC Wealth Management


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Market uncertainty makes it hard for some families to resist the reflex to pull investments. Here’s why you should keep your 529 in place.

Graduation cap placed on top of a pile of money.

Tammi Hall has simple and hard-earned advice for parents who have seen college funds they've built up for their kids shrink as the stock market dropped dramatically in the wake of the global spread of COVID-19.

Let it be.

A finance director from Minneapolis, Hall started putting money aside for college in earnest when her now-adult daughter was five years old. When financial markets plummeted in the 2008 recession, Hall watched with dismay as the fund was suddenly cut in half. With her daughter's first year of college just seven years away, she worried the rest of it might disappear. Against the advice of her financial advisor, she pulled the money and placed it in a regular savings account in hopes of protecting what remained.

She now realizes that was the wrong call. “I should have listened to the advice I was given, that it was going to come back at some point," Hall says. “And even if the market didn't go back up in time for college, by pulling it I just lost a bunch of money."

Taking the emotion out of investing

Hall wasn't alone in abandoning her investment plans during the darkest hours of the recession. “In the financial crisis, we saw a number of people who just said, 'I can't take it anymore,'" says Janet Engels, director of the Portfolio Advisory Group, U.S. Equities, at RBC Wealth Management-U.S. “And the biggest challenge with that is people simply did not get back in, because they couldn't identify a specific catalyst that made them comfortable reinvesting funds."

In early March of this year, stocks suffered their worst week ever, with many of the companies in the Dow Jones losing 20 percent or more of their value. But Engels says there's a key difference between the period we're in now and the global recession we were in more than a decade ago, when we experienced a breakdown in the financial system that ultimately hurt the economy. “What we have today is the reverse of that—a self-induced coma on the part of economies around the world which has led to a decline in economic activity, corporate earnings and share prices," she says. “If I had to be in either of them, I'd rather be in the one we're in today, because there's greater potential for a quicker recovery in economic activity."

Still, dire headlines about markets make it hard for some families to resist the reflex to pull investments in times of financial turbulence. But it's critical to remember that pulling money out of a 529 plan can end up costing much more in the long run, says Angie O'Leary, head of wealth planning at RBC Wealth Management-U.S.

“It's essentially a triple whammy. You pay a penalty plus federal taxes on any money withdrawn from 529 plans that doesn't go toward education costs," says O'Leary. “You may also miss out on the returns that will come if you keep the money where it is. History shows that markets typically recover. It's just a matter of time."

Smart spending choices for your 529 plan

Distributions from tax-advantaged 529 plans can cover tuition and fees, campus housing and meal plans, rent for off-campus housing, books and supplies, computers and internet services, and equipment for people with disabilities, such as wheelchairs.

O'Leary says to maximize the gains in the coming months and years as college funds typically bounce back, parents with children starting college soon should consider looking for alternate ways to fund the first year of college and hold off dipping into their 529s and similar accounts.

A valuable funding source in addition to a 529 plan, says O'Leary, is for parents to tap their own line of credit. “It's realistic for parents funding higher education for one or more children to come up short or have liquidity challenges," she says. “A line of credit may offer a more cost-effective way for families to borrow money to fill in any gaps and avoid traditional student loans."

Another option is to take advantage of recent changes to federal law governing 529s, which allow families to apply those funds to up to $10,000 per person in student loan repayments for children and grandchildren. O'Leary says this is a way to repurpose 529 funds in cases where student loans are overly burdensome.

For families with younger children, it's important to continue putting money aside for college on a regular basis, if possible, O'Leary says.

Gifting options for 529 plans

“Engage your village," O'Leary says. “Forgoing material gifts and inviting others to contribute to the fund is a great way for extended family and friends to show the value of a higher education." And depending on what state they live in, it's possible they may be able to claim a deduction on their own state tax return.

In the meantime, staying the course with your long-term plans for college tuition is the smartest response to turbulent markets. Reflecting back on her decision in 2008, Hall says families should take the advice she rejected back then from her advisor. “You should stick with your plan—even if it does go down more. Typically, it's going to come back."

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Wealth planning