Can Beneficiary Swap Salvage Sinking 529 Plan

What started out in late 2007 and early 2008 as concern for some parents and grandparents as they watched balances sink on their 529 college savings plans evolved into widespread panic by the end of 2008. "College funding and 529 plan anxiety ranks among the largest concerns of parents," says Brad Lazarus, who runs Chicago-based Omega Advisors, an hourly, as-needed financial planning firm. "Parents are extremely distressed by the crisis in the markets." It's no wonder: 529s typically comprise a significant percentage of a family's net worth. Adding to the angst: "Many people were trying to squeeze the last little bit of return on their money before selling off, even though college was next fall or a year away," says Ray Lucia, CFP, and host of a daily Business Talk Radio Network show. Could changing the beneficiary on a 529 plan be the answer? Those with leftover funds in a 529 after paying for a child's education rarely think twice about changing the beneficiary to avoid the tax consequences of cashing out the account. Making a younger child beneficiary of the 529 could provide time to recoup losses before spending that money. Lazarus says it's similar to pre-retirees delaying retirement day. "There aren't any costs or fees or tax consequences to change the beneficiary," says Robert Fierman, CFP, senior vice president of Raymond James & Associates. Some 529 plans do only allow one beneficiary switch per year, though. Considering a switch In Todd W. Sivak's experience as a CFP for Integrated Financial Solutions in Wisconsin, people view 529s, "as a means to help fund education for all of their children" and should understand going in that they have the flexibility to make a lateral beneficiary change to a younger sibling. Sivak knows of some parents considering paying out of pocket for their first child's education and allocating funds to the youngest child in order to "buy time" and hope for a value comeback. But considering isn't necessarily doing. "This is happening far less than one thinks simply because most parents try to treat their children equally and can't bring themselves to sacrifice one child's education for the sake of another," says Lee Rosenberg, CFP, co-founder of ARS Financial Services, based in Long Island, N. Y., and a blogger for trustedexpertnetwork.com. "It's like taking bread out of one child's mouth to feed another. It may come up in conversation, but implementation is a very different matter." Still, it could be a good idea. "No one likes to work hard to save for a future goal only to see that investment account be reduced by 40 percent or more," says Sivak. "If they can delay withdrawing funds and give the account time to come back with the market, it's both a financial and mental win." The actual process for switching the designated beneficiary is simple as well, and can be done by completing a form on hard copy or online, says Joe Hurley, CPA, founder of Savingforcollege.com. In terms of qualifying for financial aid, he adds that switching to a younger sibling shouldn't make a difference under federal rules -- although it wouldn't hurt to check with the college if that decision has been made, "to see if (its) interpretation would allow the younger sib's 529 to be kept out of parent assets on the older sib's FAFSA." And as for the new beneficiary there's, "a rather extended list of who qualifies," says Fierman, citing not just siblings but also cousins, stepfathers, nieces, etc. The new beneficiary might also be a nonfamily member, but that switch could affect taxes. (If the account has no gains, the owner could avoid a 10 percent penalty as well as income tax consequences, he says). Cautions and drawbacks Sound like a plan? Not so fast, advisers say. "The fact remains that the financial markets are down nearly 50 percent from their highs," says Lazarus. So despite a beneficiary change, the shortfall in assets would still be there. Yes, the younger child would be in better shape, but then the parents are, "responsible for contributing more for the older child in a shorter period of time. It will create a strain on the finances, regardless of who the beneficiary is today. It is essentially switching dollars from your left hand to your right." Another reality, notes Steven J. Bloch, CFP, managing partner of California-based MHB Financial Group, is that switching beneficiaries at a time when the account has lost value can work against you, especially if you've chosen an age-based investment for the younger child. That "would actually expose you to a more equity-heavy portfolio, which is currently viewed as much riskier." Sivak points to a few "what-if's" as additional drawbacks. The new beneficiary may decide not to attend school, or may receive a scholarship and not "need" the funds. The rules of the game regarding 529s could also change and mean less flexibility or more negative tax implications. Don't forget, too, that tuition costs are rising, Sivak says, so the purchasing power of the account could be reduced (that's "could be" and not "would be" because the younger the new beneficiary, the more opportunity for growth that might offset the higher tuition). For those scared away from a beneficiary switch, there are other options: Take the loss: Sivak says this option is beginning to get the attention of those whose plan balances are underwater from the original contribution amounts. The remaining dollars can be invested outside of the 529 plan. Frank J. Ruffing, CFP, of Farragut Resources in Virginia, says closing the plan and booking the loss "as an itemized deduction on the owner's taxes is the most compelling solution" he's seeing. "For owners who funded the plans aggressively, for two kids, it meant a $90,000 write-off in one case I've seen." (Ruffing has generally been counseling clients to stop funding 529 plans and save outside.) For 529 plans funded by gifts from grandparents, Bloch says it's not uncommon to be considering putting the money from a 529 plan that's below principal into an investment that would protect the principal (provided a suitably "safe" investment doesn't exist within the plan), then when the market seems to be on the upswing, taking advantage of the five-year gift exception to pu t the money back into the plan. Wait for a market recovery: Fierman says this is the best strategy for when college is still a while off. Thomas Bates, CFP, owner of Thomas R. Bates, CFP, LLC in Ohio, has a similar recommendation, provided the first tuition payment is five years away or more. Bloch says one strategy that could potentially work here is to, "overfund an older child's account, gain the power of compounding, and shift a portion of the overfunding to the younger child before the eldest child begins college." It would be like getting a head start on the younger child's education fund, he says, adding that it's not simply the time horizon but the underlying investments in the account that will be a key to recouping losses. Use other assets for current college bills: Fierman suggests looking to CDs, bonds and money markets that have held up well to fund the first few years of expenses. "If college expenses are paid for now with other assets, the owner has until December of the next tax year to pull money out of the 529 to reimburse themselves. This at least gives almost two years for the account to begin to recover." The hope, then, would be that for the last few years of college the account funds could cover tuition expenses. Decision time Still thinking a beneficiary switch is the best option for your family, or that you may need to do it down the road? Lazarus advises parents to take advantage of the long-term lows in the market now. But the key is to immediately invest once the assets land in the new beneficiary's account. "The worst thing that can happen would be selling out of the funds when the Dow Jones is at 7,000, then procrastinating and re-buying the funds when the Dow Jones is back up to 8,000," he says. Yet the switch could be made at any time, provided it happens before the funds are used. "You certainly want to be sure that the change is made before you withdraw the first dollar for the younger child's education," says Sivak. "You must be able to make a clear connection of the withdrawal for tax purposes." He says that while, "today many of us may not have a tax issue as the values have fallen below the total contributions thus far, that may not be the case 10 years from now." Posted March 6, 2009 What started out in late 2007 and early 2008 as concern for some parents and grandparents as they watched balances sink on their 529 college savings plans evolved into widespread panic by the end of 2008. "College funding and 529 plan anxiety ranks among the largest concerns of parents," says Brad Lazarus, who runs Chicago-based Omega Advisors, an hourly, as-needed financial planning firm. "Parents are extremely distressed by the crisis in the markets." It's no wonder: 529s typically comprise a significant percentage of a family's net worth. Adding to the angst: "Many people were trying to squeeze the last little bit of return on their money before selling off, even though college was next fall or a year away," says Ray Lucia, CFP, and host of a daily Business Talk Radio Network show. Could changing the beneficiary on a 529 plan be the answer? Those with leftover funds in a 529 after paying for a child's education rarely think twice about changing the beneficiary to avoid the tax consequences of cashing out the account. Making a younger child beneficiary of the 529 could provide time to recoup losses before spending that money. Lazarus says it's similar to pre-retirees delaying retirement day. "There aren't any costs or fees or tax consequences to change the beneficiary," says Robert Fierman, CFP, senior vice president of Raymond James & Associates. Some 529 plans do only allow one beneficiary switch per year, though. Considering a switch In Todd W. Sivak's experience as a CFP for Integrated Financial Solutions in Wisconsin, people view 529s, "as a means to help fund education for all of their children" and should understand going in that they have the flexibility to make a lateral beneficiary change to a younger sibling. Sivak knows of some parents considering paying out of pocket for their first child's education and allocating funds to the youngest child in order to "buy time" and hope for a value comeback. But considering isn't necessarily doing. "This is happening far less than one thinks simply because most parents try to treat their children equally and can't bring themselves to sacrifice one child's education for the sake of another," says Lee Rosenberg, CFP, co-founder of ARS Financial Services, based in Long Island, N. Y., and a blogger for trustedexpertnetwork.com. "It's like taking bread out of one child's mouth to feed another. It may come up in conversation, but implementation is a very different matter." Still, it could be a good idea. "No one likes to work hard to save for a future goal only to see that investment account be reduced by 40 percent or more," says Sivak. "If they can delay withdrawing funds and give the account time to come back with the market, it's both a financial and mental win." The actual process for switching the designated beneficiary is simple as well, and can be done by completing a form on hard copy or online, says Joe Hurley, CPA, founder of Savingforcollege.com. In terms of qualifying for financial aid, he adds that switching to a younger sibling shouldn't make a difference under federal rules -- although it wouldn't hurt to check with the college if that decision has been made, "to see if (its) interpretation would allow the younger sib's 529 to be kept out of parent assets on the older sib's FAFSA." And as for the new beneficiary there's, "a rather extended list of who qualifies," says Fierman, citing not just siblings but also cousins, stepfathers, nieces, etc. The new beneficiary might also be a nonfamily member, but that switch could affect taxes. (If the account has no gains, the owner could avoid a 10 percent penalty as well as income tax consequences, he says). Cautions and drawbacks Sound like a plan? Not so fast, advisers say. "The fact remains that the financial markets are down nearly 50 percent from their highs," says Lazarus. So despite a beneficiary change, the shortfall in assets would still be there. Yes, the younger child would be in better shape, but then the parents are, "responsible for contributing more for the older child in a shorter period of time. It will create a strain on the finances, regardless of who the beneficiary is today. It is essentially switching dollars from your left hand to your right." Another reality, notes Steven J. Bloch, CFP, managing partner of California-based MHB Financial Group, is that switching beneficiaries at a time when the account has lost value can work against you, especially if you've chosen an age-based investment for the younger child. That "would actually expose you to a more equity-heavy portfolio, which is currently viewed as much riskier." Sivak points to a few "what-if's" as additional drawbacks. The new beneficiary may decide not to attend school, or may receive a scholarship and not "need" the funds. The rules of the game regarding 529s could also change and mean less flexibility or more negative tax implications. Don't forget, too, that tuition costs are rising, Sivak says, so the purchasing power of the account could be reduced (that's "could be" and not "would be" because the younger the new beneficiary, the more opportunity for growth that might offset the higher tuition). For those scared away from a beneficiary switch, there are other options: Take the loss: Sivak says this option is beginning to get the attention of those whose plan balances are underwater from the original contribution amounts. The remaining dollars can be invested outside of the 529 plan. Frank J. Ruffing, CFP, of Farragut Resources in Virginia, says closing the plan and booking the loss "as an itemized deduction on the owner's taxes is the most compelling solution" he's seeing. "For owners who funded the plans aggressively, for two kids, it meant a $90,000 write-off in one case I've seen." (Ruffing has generally been counseling clients to stop funding 529 plans and save outside.) For 529 plans funded by gifts from grandparents, Bloch says it's not uncommon to be considering putting the money from a 529 plan that's below principal into an investment that would protect the principal (provided a suitably "safe" investment doesn't exist within the plan), then when the market seems to be on the upswing, taking advantage of the five-year gift exception to pu t the money back into the plan. Wait for a market recovery: Fierman says this is the best strategy for when college is still a while off. Thomas Bates, CFP, owner of Thomas R. Bates, CFP, LLC in Ohio, has a similar recommendation, provided the first tuition payment is five years away or more. Bloch says one strategy that could potentially work here is to, "overfund an older child's account, gain the power of compounding, and shift a portion of the overfunding to the younger child before the eldest child begins college." It would be like getting a head start on the younger child's education fund, he says, adding that it's not simply the time horizon but the underlying investments in the account that will be a key to recouping losses. Use other assets for current college bills: Fierman suggests looking to CDs, bonds and money markets that have held up well to fund the first few years of expenses. "If college expenses are paid for now with other assets, the owner has until December of the next tax year to pull money out of the 529 to reimburse themselves. This at least gives almost two years for the account to begin to recover." The hope, then, would be that for the last few years of college the account funds could cover tuition expenses. Decision time Still thinking a beneficiary switch is the best option for your family, or that you may need to do it down the road? Lazarus advises parents to take advantage of the long-term lows in the market now. But the key is to immediately invest once the assets land in the new beneficiary's account. "The worst thing that can happen would be selling out of the funds when the Dow Jones is at 7,000, then procrastinating and re-buying the funds when the Dow Jones is back up to 8,000," he says. Yet the switch could be made at any time, provided it happens before the funds are used. "You certainly want to be sure that the change is made before you withdraw the first dollar for the younger child's education," says Sivak. "You must be able to make a clear connection of the withdrawal for tax purposes." He says that while, "today many of us may not have a tax issue as the values have fallen below the total contributions thus far, that may not be the case 10 years from now." Posted March 6, 2009