529 Accounts Gain Investment Flexibility

Change applies only to 2009

By Kaye A. Thomas
Posted January 2, 2009

An extra chance to make a mistake?

One of the best ways to save for college is in a 529 account. These accounts offer federal income tax benefits and in many cases provide state income tax benefits as well. Broadly speaking, they work like a Roth IRA: you get no deduction when contributing to the account, but investment earnings are tax-deferred and, if the account is used for qualifying purposes, tax-free.

One potential drawback with these accounts is a restriction on investment flexibility. In a Roth IRA (and most other kinds of investment accounts) you can choose just about any investment and change to a different investment whenever you want. The rules for 529 accounts limit your investments to the specific choices offered by the plan you're using, and allow you to change that selection only once in each calendar year, with one exception: an investment change is permitted when there's a change in the beneficiary of the account, without regard to the calendar year rule.

IRS loosens up

The IRS has announced a more flexible rule for 2009 "in response to concerns that have been caused by the recent condition of the financial markets." (Click for PDF.) For this year only, you are allowed to change the investment strategy of your account twice without changing beneficiaries. The previous rule permitting additional changes in connection with a change in beneficiary continues to apply.

Choose wisely

This flexibility may allow you to make timely moves. Inevitably, though, some people will use it to move out of stocks at the worst possible time, near the bottom, and stay out until an upward trend appears to be firmly established — and they have missed out on much of the recovery. Ultimately you need to be comfortable with your investment choices, but a strategy based on a guess about which way the market is heading lacks a solid foundation.