Saving a Dollar Today is Better than Borrowing One Tomorrow®. But, HOW should you save?
Over 17 million families have saved more than $500 billion in 529 saving plans and another $26 billion in prepaid 529 plans. Unlike the better-known savings plans, prepaid tuition plans allow families to lock in current tuition rates for future use. This article compares 529 prepaid and 529 savings accounts. Then we dive deeper into 529 prepaid programs: how they work, their benefits and limitations, and how they can be used in conjunction with 529 savings plans.
Be Aware, Don’t be Afraid!
At the end of the day, choosing a college is (should be) a consumer decision just like buying a car or home. Similarly, investing in a 529 Plan requires a consumer decision: doing research to see which investment offers the best opportunity to achieve your goals and objectives, and then making the investment. Don’t wait until tomorrow because tomorrow is easily postponed when it comes to savings.
To help you make a more informed decision, here are several excellent sources of more information about 529 plans:
- The Internal Revenue Service offers these FAQs and this overview of 529s.
- The National Association of State Treasurers’ College Savings Plans Network has this “Find My State’s 529 Plan” as well as a “529 Search and Comparison” tool.
- The College Savings Foundation.Org offers this post on saving for college.
- The blog at MyCollegeCorner.com has numerous posts regarding 529s including “529 Plans: A Bad Name for a Great Way to Save for College.”
Understand the Types of 529 Plans
All 529 plans come under the jurisdiction of, and are named after, Section 529 of the Internal Revenue Code. The goal of 529 plans is to offer families easy ways to save for college with federal, and often state, tax-advantages:
- 529 Savings Plans
- Like non-education savings accounts, contributions are invested in mutual funds or other securities.
- The account value fluctuates based on market performance.
- Used to pay for a wide range of qualified education expenses, including tuition and fees, housing, meals, books, and other costs to attend the college.
- Savings are not required to be used at schools in the state that sponsors the applicable plan.
- Plans from any state can be selected.
- Prepaid Tuition Plans (“529 Prepaids”)
- Allow families to purchase a portion of tuition in the future at today’s prices.
- Generally, cover the cost of tuition and mandatory fees only.
- Often open to in-state residents only.
- Typically tied to specific schools in a state or a group of colleges, i.e., State Colleges or, in the case of the Private College 529 Plan, member Private Colleges.
Key Benefits of 529 Prepaids
- Protection from Rising Tuition Costs: One of the biggest advantages of prepaid plans is locking in future tuition prices at today’s rates, shielding families from future tuition hikes. Prepaid plans provide a predictable and secure way to pay for future tuition. No matter how much tuition costs increase, your future cost has been locked in.
- Tax Advantages: In addition to the initial benefit of tax-free growth until the student starts college and for qualified distributions, many states also offer tax deductions or credits for contributions.
- Flexibility for Other Savings: With tuition costs locked in, parents, grandparents, and others can also set up a 529 Savings Plan for a student to pay for other qualified educational expenses, such as housing, meal plans, transportation, etc. Knowing that some or all future tuition is covered, families can plan more confidently for other expenses.
- Permits Strategic Use of the Tuition Lock:
- Reallocate some or all of 529 Savings to a 529 Prepaid program once a student narrows down a college list or seems to be leaning toward a particular college or group; i.e., mostly public colleges in states offering a prepaid program or the College Well/Private College Plan for these private colleges.
- Lock in tuition costs for future years (junior or senior year?) once a student has been accepted.
Potential Limitations of 529 Prepaid Tuition Plans
Despite their benefits, prepaid tuition plans have limitations that families should consider:
- Limited to Specific Colleges: Most prepaid plans are designed for in-state public colleges and universities. If the beneficiary chooses an out-of-state institution or a private college, it may not be covered by plan. While you can still get your money back in these cases, you will generally lose out on some of the plan benefits and return on the investment.
- Limited to Tuition and Fees: Unlike savings plans, which can be used for a broad range of qualified education expenses, prepaid tuition plans cover only tuition and mandatory fees. Other costs, like housing, food, and books, are not covered.
- Program Details Vary: The way that a family locks in today’s prices for tomorrow’s tuition varies by program. Some state-sponsored prepaid tuition plans require either the account holder or the beneficiary to be the state resident at the time of purchase or use.
- Limited Enrollment Periods: Prepaid tuition plans often have specific “enrollment” periods in which a family may invest in the program. 529 savings plans accept first-time and subsequent contributions at any time.
More to Consider
Although 529 Prepaids can only be used to pay for tuition and fees, they offer families an opportunity to:
- Ensure that they are protected against future tuition increases that might exceed the gains on their savings. So, the problem of college tuition inflation outpacing savings is eliminated.
- Purchase 100% or less of future tuition at participating colleges.
- Use a Prepaid Plan to lock in the cost of future tuition and fees, and a 529 Savings Plan for other college expenses. Although the residency requirements likely limit which 529 Prepaid works for you, there is no such limitation on 529 Savings Programs. You can use any 529 Savings Plan in the country and the prepaid program that covers the college(s) of interest.
- Benefit from the same flexibilities at 529 Savings Plans such as rolling the savings into a Roth IRA.
Examples of 529 Prepaid Tuition Plans
There is one national prepaid plan and nine state-based prepaid tuition plans across the United States, named here with links to their landing pages with emphasis (bold) added to show the state sponsor:
- Private College 529/College Well, a national program managed by Tuition Plan Consortium
- Florida Prepaid managed by Florida Prepaid College Board
- College Illinois! 529 prepaid tuition program managed by Illinois Student Assistance Commission
- U.PLAN offered by the Massachusetts Educational Financing Authority
- Michigan Education Trust managed by MET Board of Directors and Michigan Department of Treasury
- Mississippi Prepaid Affordable College Tuition Plan (MPACT) managed by the Mississippi Treasury Department
- Nevada Prepaid Tuition Program managed by the Nevada State Treasurer’s Office
- PA529 Guaranteed Savings Plan managed by the Pennsylvania Treasury Department
- Texas Tuition Promise Fund managed by Orion Advisors Solutions, Inc
- Guaranteed Education Tuition managed by the Washington Student Achievement Council
Virginia529 replaced its prepaid program with the Tuition Track Portfolio in its Invest529 savings plan. Tuition Track investments grow at the same rate as the Average Tuition at Virginia public college and universities.
How to Choose a Plan
When deciding between a 529 prepaid tuition plan and/or a 529 savings plan, consider the following factors:
- Intended School Choice: If you’re confident your child will attend an in-state public college, a prepaid plan can be a cost-effective option. If you want flexibility for private or out-of-state schools, a savings plan may be better. Or you can use both.
- Risk Tolerance: Prepaid plans offer certainty, while savings plans expose you to potential market gains and losses.
- State Tax Benefits: Check your state’s tax policies to understand if it offers a state tax credit or deduction for 529 plan contributions.
- Other Costs: Remember that prepaid plans typically only cover tuition and fees. Savings plans offer broader coverage, including room and board. And you may use two or more plans to lock in future tuition costs while also saving for other qualified education expenses.
Is a 529 Prepaid Tuition Plan Right for You?
Whether a 529 prepaid tuition plan is the right choice depends on your family’s financial goals and your tolerance for risk, among other things. Prepaid plans are ideal for families who:
- Have children who are likely to attend a college or university covered by one of the plans.
- Want a low-risk way to save for college without exposure to market volatility.
- Prefer predictable, structured payments.
However, if you prefer flexibility or are unlikely to send a child to one of the schools participating in a prepaid plan, a traditional 529 savings plan might be a better initial option. Savings plans can cover a broader range of expenses, including housing and food, and they can be used at any accredited institution.
Keep in mind that you can always make a withdrawal from a 529 Savings Plan to purchase locked-in future tuition if your student(s) decides to narrow their college list to schools that participate in a prepaid program, or if they are accepted, and you want to lock in future costs.
Conclusion
529 prepaid tuition plans offer a compelling, secure way to save for future college costs, especially for families concerned about rising tuition. By locking in today’s rates and offering tax advantages, these plans can provide peace of mind. However, it’s essential to understand their limitations, such as restricted use and reduced flexibility, before committing. Carefully review the plan details and, if you can, consider consulting an advisor to determine the best approach for your family’s education savings strategy.
Planning for college is a long-term investment. The right plan can make higher education more affordable and achievable, setting your child on a path toward future success.