How to protect your college savings as the stock market gyrates

Nuthawut Somsuk

With the stock market tumbling amid the coronavirus outbreak, you might be worried about meeting your financial goals. And if you had hoped to tap a 529 college savings plan for an upcoming tuition bill for your child or grandchild, well, you might be really worried.

Those state-sponsored investment plans allow parents to save money and then withdraw it tax-free, so long as the money is used for certain education expenses.

Many of the accounts are likely in the red as of late. Stocks suffered their worst week since 2008 at the end of last month, with most companies in the S&P 500 losing 10% or more of their value.

However, experts say if you have the appropriate asset allocation in your college savings plan, the recent declines shouldn’t be too painful.

Ideally, college savers would be enrolled in “age-based” 529 accounts, which automatically tilt toward more conservative investments, such as bonds and certificates of deposit, as those tuition bills roll around, said Mark Kantrowitz, publisher of SavingForCollege.com. (Two-thirds of families are invested in such accounts, he added.)

Just how conservative are we talking?

“If your child will be enrolling in college within the next two years or is already in college, you should have no more than 20% invested in equity funds,” Kantrowitz said.

That way, he said, “losses are minimal and there is little harm in taking a distribution now.”

If your 529 savings plan does not reflect your child’s age, a looming tuition payment could force you to sell your stocks at a discount “as painful as that might be,” said Scott Clemons, chief investment strategist at Brown Brothers Harriman.

There can be other options, however.

For example, if you believe the current volatility will be temporary, you might consider delaying distributions from you plan, Kantrowitz said: “You want to sell when it’s best to maximize your returns, not because you need to pay the college bills.”

To that end, you might use any available cash on hand or even loans while the market gyrates, and then dig into your 529 account at the end of 2020 to reimburse yourself. Keep in mind: To avoid penalties, those qualifying distributions must be taken the same year as the expenses.

If you’re in the fortunate position in which you don’t need to use the funds in your 529 account to pay for your child’s college expenses at all, it can be worthwhile to wait for the market to recover and then take out the money for other bills and absorb the penalty cost of a non-qualified distribution, Kantrowitz said.

Here’s what that will cost you: ordinary income taxes plus a 10% tax penalty. Still, Kantrowitz estimates that the penalty typically comes out to under 3% of the account’s balance. “The family is no worse off than they’d be in a taxable account,” he said.

As for savers with younger children, they should avoid panic all together. Recovery time abounds.

Market downturns are simply part of the college saving experience, Kantrowitz said.

During any 17-year period, he calculates, the stock market typically will suffer at least three corrections (considered a drop of 10%) and at least one bear market (a drop of 20%).

Still, in the wake of the 2008 financial crisis, around 10% of investors liquidated their entire 529 accounts, and 20% switched to less risky assets, Kantrowitz said. (He surveyed the savers in 2010).

“These investors missed out on the economic recovery,” he said.

The coronavirus has wreaked havoc on the stock market. How to protect your college savings.