College savings is a hot topic with my clients, as many of them have at least one child living at home. In June, I wrote an overview article on 529 plans as a college savings strategy. Since then, I’ve fielded a couple of questions from parents and inquiries from college experts.
Today, let’s dive deeper into the two main types of 529 plans: savings and prepaid.
529 College Savings Plans
529 college savings plans are the more common type of 529 plan. You establish the plan in the state of your choosing (not necessarily your home state), either directly or through an adviser. Investments are selected that will hopefully increase over time.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
As a fee-only Registered Investment Advisory (RIA) firm owner, I am always acting as a fiduciary and looking out for my clients’ best interests. Direct 529 savings plans are available for lower cost than their adviser-sold alternatives, so they typically “win” in my book. Nonetheless, any investor who directly opens a 529 savings plan account should know that there is underlying investment risk. It will fluctuate in value! Investment selections that are aggressive and equity-heavy will naturally have more price fluctuations because they are aligned with stock market performance.
529 savings plan balances grow tax-deferred and can be used for a plethora of higher-education expenses, including tuition, fees and room and board (for students enrolled at least half-time). State income tax deductions may be offered for 529 saving plan contributions, but deductions are state specific. My home state of Missouri is one of a few tax-parity states that offer a state income tax deduction even if funding an out-of-state 529 savings plan. Other states, such as California and North Carolina, offer no income tax deduction for 529 plan contributions.
Prepaid Tuition Plans
Within a prepaid plan, you buy tuition credits at a set price (typically a premium over the current cost of college) to be used for your child’s education years down the road. Historically, prepaid plans were state run and offered advance tuition credits for in-state universities only.
Private College 529 is the only 529 plan not run by a state, and the member college guarantees that your family purchases tomorrow’s tuition at today’s prices in the form of tuition certificates. My alma mater, Saint Louis University, is one of nearly 300 participating universities for Private College 529; view the full list here. Tuition can be used at any existing or future member schools. Another bonus? The account owner doesn’t pay any fee to establish or maintain the plan; all deposits are directly used to pay tuition. Consult this FAQ section for all the details on prepaid plans from Private College 529. One downside? Prepaid plans usually can only be applied to tuition and mandatory fees — not room and board.
Market Risk
One major benefit of the prepaid, Private College 529 plan is that you avoid market risk. Let’s say your son is five years away from attending college and you put $10,000 into the prepaid plan now. Suppose that covers 40% of first-year tuition (which currently runs at $25,000); it will still cover 40% of the first-year tuition at your son’s private college in five years.
If instead, you opened a 529 Savings Plan and funded it with $10,000 today, the account may only be worth $8,000 when your son needs it in five years. Tuition may have increased to $30,000, so you’re only funding 26.7% of first year tuition in that scenario. If you’re optimistic, suppose you contribute $10,000 to a 529 savings plan today and it increases to $14,000 in five years. If tuition is $30,000 in five years, you’ve funded 46.7% of first-year tuition. That percentage variance is solely attributable to investment performance.
Still Confused?
For you visual learners, my wordy explanation above may be too much. Instead, here’s a comparison tool between a state-run 529 college savings plan and the prepaid Private College 529:
| Header Cell - Column 0 | 529 Plan Type | |
|---|---|---|
| Description | Savings | Prepaid(Private College) |
| Account earnings grow tax-deferred | ✔ | ✔ |
| Can change beneficiary designation | ✔ | ✔ |
| Choice of colleges to attend | ✔ | ✔ |
| Counted as parental, not student, asset on FAFSA | ✔ | ✔ |
| State run | ✔ | Row 5 - Cell 2 |
| Direct or adviser-sold plans | ✔ | Row 6 - Cell 2 |
| State income tax deductions available | ✔ | Row 7 - Cell 2 |
| Room and board are "qualified expenses" | ✔ | Row 8 - Cell 2 |
| Tomorrow's tuition for today's dollars | Row 9 - Cell 1 | ✔ |
| No market, or investment, risk | Row 10 - Cell 1 | ✔ |
| No fees paid by the account owner | Row 11 - Cell 1 | ✔ |
Wrapping it Up
It would be wise to open a prepaid Private College 529 if you are insistent on sending one or more of your children to an eligible private university and want to lock in today’s tuition rates. If you want more flexibility and are willing to take some investment risk, the 529 savings plan could be a better alternative. Some families open one of each 529 plan (prepaid and savings).
Did you find this article helpful? Then please share it.
If you have additional questions about 529 plans or college savings, SavingforCollege.com is an excellent resource. I’m now one of their Financial Pros with access to premium tools and calculators and am also happy to talk about your specific situation. Click here if you’d like to set up a complimentary consultation with me.
-
How to Plan for Retirement When Only One Spouse WorksWhen you're married but only one spouse works, leaving retirement planning to the working partner puts financial security at risk. A joint effort is vital.
-
Can a Judge Tell a Father to Avoid Risky Triathlons for His Sons?Mom wants Dad to quit participating in triathlons, which are known to have a higher risk of sudden cardiac death, but would a family law judge force him to stop?
-
Should You Trust Robo-Advisers With Your Retirement?Why use a financial adviser when you can get retirement planning tools online? The simple answer: Tech can't yet replace nuanced advice from a professional.
-
Unpaid Caregivers Soon May Get Help to Save for RetirementTwo proposed bills aim to open new doors to caregivers for contributing to Roth IRAs and making catch-up retirement contributions.
-
Time for Some Fall Financial Maintenance: Here's a ChecklistAs you rake the leaves and clean the gutters, you should also consider tackling seven key year-end planning chores.
-
Want Your Kids to Inherit? You Need an Asset Protection PlanYou've worked hard for your wealth. Don't let it fall into the wrong hands. Consider prenups, trusts and other protections to safeguard your family legacy.
-
Five Tax Strategies to Help Your Money Last in RetirementHaving a tax strategy is crucial to making your money last. These tax-saving moves can help, whether you're years from retirement or already there.
-
What Does the Term 'Full Coverage' Really Mean in Insurance?For starters, there’s no such thing as 'full coverage.' Instead, you should tell your insurer exactly what kind of protection you're looking for and for what.
