If you have money in a 529 plan to save for college, good for you.  529 plans represent one of the best vehicles for educational savings, and with the cost of tuition skyrocketing faster than anyone can keep up with, they also represent the middle class’ only hope of paying for even 1/2 of a college education in the future.

When 529 plans were created, lawmakers attempted to correct some of the perceived issues with 401(k) plans which are similar in nature, but with a different goal.  One of those issues was that the majority of 401(k) plan participants were doing it wrong, that is, investing incorrectly.  One such problem was changing their investments too often in response to news events or media hype.

The solution implemented in 529 plans was that they were restricted to just one reallocation per year.  In other words, if you started 2009 with half your money in the S&P 500 fund and half your money in the International fund, you could change that to something else, but only once for all of 2009.

This restriction only applies to monies already in the account and exchanging that money between investments.  You can change where NEW money goes at any time.  Thus, in the example above, the account owner could switch to 25% S&P 500, 25% International, and 50% bonds on March 1st, but then they could not adjust that mix again until 2010.  However, the investor could elect to have all future contributions to go 100% to the Money Market fund on March 20th, and could change that again on April 19th, and so on, at any time.

2 Re-Allocations Investment Exchanges in 2009

Congress passed a law changing the rules for 2009 only.  In 2009, the account owner of a 529 plan may make TWO changes to the investment allocation of the existing funds.  One could therefore make a change now, and another change in September, for example.  The extra change cannot be rolled over and it does not apply to 2010, as of this writing.

Ironically, this action only proves the point.  Congress knows that people will be freaked out about their investments this year.  That means they will want to make the same kind of current events based investment decisions that were trying to be avoided by having the once a year rule in the first place.  Doubly ironic, is the fact that if one were going to “go safe” it probably should have been done in 2008.

With the new twice this year feature, Congress allows people to go safe now (too late) and then go back to “normal” later this year (probably too late as well). 

If you are sitting across the dinner table from a 15 year old, then you have a pretty tough call to make, especially if you have already rung up huge losses.  You are still probably better off sitting on the investment strategy you calmly and carefully analyzed when you were not scared, assuming that is how you picked your investments in the first place.  While there would only be 3 years until the account was started to be withdrawn, if you are looking to use the money over a full 4 or 5 years, then you are still looking at 7 or 8 years total.  There will most likely be some kind of recovery during that period.

Bond prices can only go down from here because higher interest rates cause lower bond prices and interest rates are already at zero…

If you are looking at someone under 10, do NOT panic.  Now is not the time to go 100% bonds, and it is most certainly NOT the time to go 100% money market.  The 20% recovery the market has already had from its lows earlier this year was the best way to get some of your money back.  You have 8+ years until the money is needed, let the markets do their work during that time.

You current contributions should be going into equities.  Pick a market index fund, or one of the “growth” allocations available in your plan.  Yes, there may be some more downside in this market, but you will be buying cheap if you are buying into stocks now. 

The opposite is true of bonds.  Never forget that bond prices go DOWN when interest rates go UP.  Interest rates are currently set at 0% basically.  That means it is GARAUNTEED that interest rates cannot go down, they can only go up.  Do the math and that means that for anything but the short-term bond prices can only go down.  Why would you buy an asset that is assured of losing value?

Once any sort of recovery begins, the Fed will have to start raising interest rates, and when they do, bond prices will fall.  The only way to avoid this is to own individual bonds and hold them until they mature.  For bond mutual funds, they can only lose money once the recovery begins.

A quick word about money market investment options: College costs are increasing at 7% per year on average.  If you are earning 3% in a money market (fat chance) you are losing 4% of buying power each year.  Yes, it is painful to watch the account value go down, but it will come back and over time, the market returns 9% to 11% depending on who you ask, and how you count.  In other words, your only hope to keep up with the 7% inflation of college tuition is to get that 9% in the stock market.  There is no other choice.

If you can’t or won’t listen, then that is too bad for your children, but AT LEAST make sure your current contributions are going into equities.  They won’t go down much more, but they could go up a lot.  Maybe that will be enough to make up for making the other decision.

Too harsh?  Leave a comment or shoot me an email.

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A client asked me what they should do with their [tag]economic stimulus[/tag] [tag]tax rebate[/tag] they will get later this year. (So will you!). Usually I tell people to pay down debt if they have any. They don’t have any. They also have already maxed out their [tag]IRA[/tag]s for 2008. But, they have kids! So I told them to put it in their [tag]529 plan[/tag]s. Then, the lights came on and the chorus sang.

Here in Colorado you get a state [tag]income tax[/tag] deduction for every dollar you put in a Colorado 529 plan. Although this varies from state to state, many states have some sort of [tag]tax deduction[/tag] available if you are using the in-state plan (which is why your advisor should have gone over in detail with you about your state plan before he put you in another state’s plan. If he/she didn’t, you might have a bad advisor.)

How awesome is this? You get money from the federal government as part of this stimulus package. That money is not only free money, but it is also tax-free money. So, if you put that money somewhere that will give you a tax break, you are making even more money! Here in Colorado it is like getting a 4.5% bonus on your rebate. You get the rebate plus 4.5% more back in the form of dollars off of your 2008 [tag]taxes[/tag]. Plus, your kids have more money for college.

If you qualify for a deductible IRA contribution, put the money in there and you can get a federal tax deduction! If you are in the 30% tax bracket, that’s like getting an extra 30% on your rebate which you will get as money off of your 2008 taxes.

No kids and don’t qualify for a deductible IRA? You can still contribute to a [tag]Roth IRA[/tag]. No, you won’t get a bonus like above, but you get tax-free growth on money you never paid taxes on in the first place. Not a bad deal there either.