The No. 1 Mistake People Make With Their 529 Accounts

For nearly 20 years, you may have been saving for your child’s education using a 529 plan. Now that it’s time to begin withdrawing, you may be panicking. The stock market has had its worst year in decades, and your account may have declined too.

But a recession isn’t a certainty, and neither is losing your investment in your future student’s college education.

Instead, one of the most crucial money moves you can make before the next recession is to invest wisely, not to hit pause on investing altogether. Staying calm and investing deliberately is key to weathering an economic downturn and emerging with your 529 intact.

Don’t close your account

For better or worse, 529 accounts function like IRAs or 401(k)s. The money you put away for your student doesn’t sit in a savings account accruing interest. Instead, it gets invested, which means you stand to reap greater rewards when the economy is doing great … or stand to lose a lot when it isn’t.

In a volatile market like 2022, your first impulse might be to yank all the money from your kid’s 529 and close the account. If you’ve seen the value of your account decline with the market, getting out while the getting’s good might feel like the smartest choice.

Take a deep breath, then remind yourself that closing an account right now will almost certainly harm your student’s tuition savings in the future. Here’s why.

Closing an account ‘locks in your losses’

Closing an account or selling the holdings for cash for the short term basically ensures you won’t make as much in the long run.

As two financial planners with investment firm T. Rowe Price put it, “Pulling out of equity markets when they are at a low point effectively locks in your losses while preventing you from benefiting from any future upswings in the market that can help you recover previous losses.”

In other words, the value you lose in closing an account or moving to cash stays lost — you have no chance of getting it back in a future upswing. If you keep the account open, though, you’re likely to regain those losses in the future, even if you have a short-term decline.

Inflation keeps your dollar from going as far

The biggest news story of the year is that inflation has exploded. The Fed is working on it, but we still don’t know how long it will take for prices to deflate. As a result, your dollar won’t go as far today as it would have a year ago.

Your money will be worth more when inflation inevitably decreases, and whether it takes a few months or a few years, it will decrease. You need to ride it out. Keeping the cash in your account now will pay off later.

Tuition costs haven’t decreased (and likely won’t)

The cost of living increased this year, and college tuition hasn’t decreased to help compensate. Instead, per data from the National Center for Education Statistics, private colleges increased tuition by 18% over the last decade, and public colleges by 13%.

In fact, in 2021, a year of tuition at a private college exceeded $36,000. For the 2023 academic year, that number will almost certainly be higher.

Most parents, guardians, and grandparents don’t have $36,000 stored in a 529 account (the average amount in a 529 account is around $29,000), which means every penny counts. Waiting until the dollar regains some value will help your future student cover more costs and live with less debt.

Focus on small course corrections, not drastic changes

If you’ve decided not to close your account, you’ve already avoided the biggest mistake you can make with your 529 before an economic downturn. But your next impulse might be to make a huge change to your investment strategy.

After all, the market itself is volatile and unpredictable, so maybe making your own dramatic investment change will keep you ahead of the curve. Right?

Wrong. The best way to protect your investments during a potential recession is to keep calm and carry on. Avoid panic and make smaller, measured adjustments to your financial plan instead of drastically changing course.

Make age-based investment decisions

Alright, but what does a measured approach to investing actually look like?

When your 529 beneficiary is young, it’s generally considered OK to make riskier investment choices. Investing the portfolio in equities offers the potential for greater growth, and if the market declines, it has time to rebound. It's a good time to take a risk that you might make more money.

As your kid nears college age, though, it’s vital to make more conservative investment choices. Risky investments — those that will either make you a lot of money or devastate your account — now have immediate consequences. Most importantly, these choices determine whether or not your child can afford their first year of college soon and can begin planning how to choose a career.

What to do if you already have an age-based plan

Many 529 accounts are already structured as age-based portfolios. If that’s the case for you, changes to the investment plan should happen automatically as your child ages.

You’ll still want to check your portfolio frequently and update contributions if your financial situation changes. For grandparents who may be investing in a 529, you may have found a way to supplement your Social Security checks or sold a piece of real estate.

Either way, the investments should reduce risk on their own without you needing to make manual changes.

What to do if you don’t have an age-based plan

If you don’t have an age-based plan, you’ll have to change your investment portfolio on your own or, preferably, with the help of a financial advisor.

You’re generally allowed to make two changes a year to your 529 account, so if you have a teenager, it’s probably time to switch to lower-risk investments. Typically, that means 529 accounts for teens are heavy on money market accounts, CDs, and government bonds.

The bottom line

Economic turmoil, up to and including a recession, doesn’t have to destroy the education future you’ve planned for your child. Instead, you can brace for the potential storm on the horizon and reduce financial stress by keeping your 529 account open, avoiding drastic investment shifts, and making measured, age-based investment decisions.