College savings is a hot topic since many of my clients have at least one child living at home. Last month, I wrote an article for Kiplinger on 529 plans as a college savings tool. Today, let’s dive deeper into the two main types of 529 plans: Savings and Prepaid.
529 College Savings Plans are the more common type of 529 plan. You establish the plan in the state of your choosing, either directly or through an advisor, and investments are selected that will hopefully increase over time.
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 advisor-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 fluctuation 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 offers 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.
Within a prepaid plan, you set aside money at today’s tuition rates for a college that your child will attend later. 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 can only be applied to tuition and mandatory fees – not room and board.
One major benefit of the prepaid, Private College 529 plan is that you avoid market risk. Let’s say your son is 5 years away from attending college and you put $10,000 into the prepaid plan now. Suppose that covers 40% of first year tuition ($25k); it will still cover 40% of the first-year tuition at your son’s private college in 5 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 5 years. Tuition may have increased to $30k, so you’re only funding 26.6% of first year tuition in that scenario. In you're optimistic, suppose you contribute $10,000 to a 529 savings plan today and it increases to $14,000 in 5 years. If tuition is $30k in 5 years, you’ve funded 46.6% of first year tuition. That 20% variance (46.6% vs. 26.6%) is solely attributable to investment performance.
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).
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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 happy to talk about your specific situation. Click here if you’d like to set-up a complimentary consultation with me.
Deb Meyer, CPA, CFP®