How to Bail Out a Sinking 529 College Plan

If you've set aside money in a 529 plan to pay for your child's future tuition, your account likely has lost a bundle in the past year.

That's not a big deal if your kid is still in diapers, but if he is bound for college soon, a sinking 529 could pose serious problems. How can you salvage what's left of college savings so Junior can get that job at Microsoft (Stock Quote: MSFT) someday?

Make sure the plan isn't too aggressive: Many 529 investment options are designed to become more conservative as your child gets older. If you have one of these target-date funds, or if your teenager's 529 is largely invested in certificates of deposit or money market funds, simply stay the course.

Otherwise, consider switching to more conservative investments within your plan. It might be appropriate to have most or all of your money in CDs or money market funds if your child is headed to college soon. The IRS typically allows you to change your plan once a year without penalties. Due to the economic crisis, you may change your plan twice, penalty free, in 2009.

Give the account some time to recover: If possible, plan on using the 529 to pay for your child's third or fourth year of college, or even graduate studies. This strategy will give the account a chance to recover what it's lost.

In the meantime, take out a loan to pay for the first few years of schooling, and be sure to pursue other potential financial aid opportunities such as grants or scholarships.

Don't wait so long to tap the 529 funds that any remaining tuition expenses are less than the account balance. That would leave you with a significant tax penalty when liquidating what's left.

Switch beneficiaries: You're allowed to change a 529 plan's designated beneficiary, so it might be best to save the money for a child still many years from college. That would give the plan assets plenty of time to recoup last year's losses.

Switching beneficiaries makes sense in other situations, too. If you end up with leftover funds in a 529 after paying for a child's education, changing the beneficiary will allow you to avoid the tax consequences that would come with cashing out the account.