Tuesday, June 22, 2010

Why should I keep my money-losing 529 vs. moving to cash or bank CDs? 529 College Savings Answers

When our readers and users of FreshmanFund.com send us questions, we'll post the answers here to help anyone searching for information on the best ways to save for someone's college education.

Ouch, I lost big money in my 529 last year! I'm considering cashing it out for savings bonds or bank CDs, why should I keep my money-losing 529?

Cashing out a 529 plan has some serious consequences. There are better alternatives. When you cash out a 529 plan, the government will tax you on any gains you may have experienced as ordinary income. You might have “gains” for the purposes of taxation even though the account statements indicate losses from the previous balance. In addition, the government will penalize you 10% of the amount you withdraw from this tax-benefitted account.

One alternative to this drastic step includes re-evaluation of your portfolio. Depending on your plan rules, you may be able to choose a different model and reinvest in a more conservative portfolio. Most plans allow a change in investment strategy on an annual basis. Another option is rolling your 529 into a different state plan, one that specifically provides for a savings account or CD-based portfolio. Five states currently sponsor such plans: Utah, Arizona, Montana, Ohio and Virginia. Thus, you can accomplish your goal of moving to cash-based investments while still maintaining the structure of the 529 and avoiding the taxes and penalties that would otherwise result.

Share your thoughts: Should the early-withdrawal penalties be repealed?

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