Strategies for Your 529 When Tuition Is Due

If you need to pay college bills this fall, you can make some key moves in your college-savings account to help stretch your money and maximize your tax breaks.

My son will start college this fall. We've lost a lot of money in our 529 college-savings account. What should we do with the account now to get ready to pay the first bill?

If you need to pay college bills this fall -- whether for a freshman or for a student in a later year of college -- you can make some key moves in your 529 to help stretch your money and maximize your tax breaks.

You can usually adjust the investment mix in your 529 only once a year, but the government is letting people make changes twice in 2009 because so many accounts lost money.

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Make sure the amount of money in your plan's conservative investment option (such as a money-market account) is enough to cover upcoming bills. Then you may still need to tweak your account, even if the money is invested in an age-weighted fund. These funds should start out in aggressive long-term investments when your child is young and gradually become more conservative as your child gets closer to college age. But when the market tanked, some state plans still had a big chunk of the money in stock funds for kids who were about to start college soon. If that happened to your account, consider switching money into more-conservative investments.

If you plan to use money from a 529 as well as from taxable accounts for college bills, consider tapping the taxable accounts for most of the bills in the early years of college or grad school. Wait until the later years to tap the 529, or make a younger child the beneficiary of the account. That way, you could sell investments in the taxable accounts for a loss (or pay taxes on a smaller gain than you would have after a good year), and then you could eventually benefit from bigger gains in the tax-free 529 if the investments bounce back. "So many of the investment decisions depend on the person's situation and whether they have money in another place they can use now or if they can pay the bills out of their regular income and wait to use the 529," says Rene Kim, senior vice-president of product services for Charles Schwab.

For more information about preparing your 529 to pay college bills after this tough year, see Salvage Your College Savings.

When deciding which pot of money to tap, also see if you qualify for the new American Opportunity tax credit, a component of the economic-stimulus plan. This credit replaces the Hope credit for 2009 and 2010 and increases the amount from $1,800 to $2,500 for qualified education expenses. You can claim the American Opportunity credit in any year of college (not just in the first two years, as was the case with the Hope credit). And the income limits to qualify have increased -- from $58,000 to $90,000 if single and from $116,000 to $180,000 if married filing jointly.

You can't double dip on tax benefits, however, so money you use to pay for college from a 529 or a Coverdell education savings account (both of which can already be used tax-free for college bills) doesn't count toward the American Opportunity credit. The tax credit is based on 100% of eligible college costs up to $2,000, plus 25% of college costs of more than $2,000, which means that you'll need to pay at least $4,000 in college costs for the year from a source other than a 529 or a Coverdell to qualify for the full credit.

You don't want to wait too long to tap a 529 account, however, because you must use the money for college costs (and you can't use it to pay back student loans). But you can use it for undergraduate expenses as well as for grad school and can always switch the beneficiary to another family member (a sibling who will be attending college or grad school later, for example). See The Best Way to Save for College for more information.

The stimulus also expanded the use of money in 529s: You can spend it on computers and Internet access in 2009 and 2010 (in the past, you could use 529 money only for computers that the school required students to buy).

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.