Saving for College in a Tough Economy (continued)

But suppose you’ve had enough and just want to cut your losses. You don’t necessarily need to pull your money out of the 529 college savings plan, as many 529 plans have added more conservative investment options, such as certificates of deposit. You can keep your money within the 529 plan but shift it into a more conservative mix of investments. But if you do want to pull the money out of the plan, you need to consider the tax consequences of such a move. Nonqualified distributions are generally subject to income tax and a 10% tax penalty. However, since 529 plan investments are made with after-tax dollars, these taxes are assessed only on the earnings portion of a distribution, not the principal. If your 529 plan has lost enough money that it is entirely in the red, the distribution will not include any earnings and hence will incur no taxes.[3] If you liquidate the plan entirely, you may even be able to deduct the losses on your income taxes as an miscellaneous itemized deduction on Schedule A of IRS Form 1040 subject to the 2% of AGI threshold. Unfortunately, you cannot treat a loss on a 529 plan as a capital loss. Also, if you take distributions from more than one 529 college savings plan, you must combine all the distributions before itemizing a loss, so gains in one 529 plan will offset losses in another.

 

For additional information and advice about saving for college, please visit FinAid’s saving for college section at www.finaid.org/savings/.

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