With the average cost of a four-year, in-state college degree hovering around $50,000, Americans across the country are jumping on the tax-advantaged 529 Plan bandwagon. But with over 80 plans on the market today, the investment field is diverse, complex and often overwhelming. How do you choose the right plan? This guide focuses on the 18 prepaid tuition plans on the market today, breaking down your costs, benefits and opportunities.
How do prepaid tuition plans work?
Prepaid tuition plans allow you to lock in today’s tuition prices at the public schools in your home state. Think of a prepaid plan as an insurance policy against rising college costs. An insurance policy with a guaranteed pay-out.
Tuition costs for four-year public colleges have increased an average of 7.2% a year since 1990. If you are a risk-averse investor, the appeal of a prepaid plan is obvious. In fact, at the current rate of tuition inflation, it might your best bet for college savings.
Sounds great, but what’s the catch?
Unfortunately, the same thing that makes these plans an attractive insurance policy also raises a red flag: tuition inflation.
With tuition inflation so high, prepaid plans run the risk of unfunded liability – in other words, their assets are smaller than their liabilities. In fact, this concern has led Kentucky, Ohio, Texas and West Virginia to freeze their prepaid plans to new enrollment. Colorado has been permanently closed.
That sounds scary, but most experts say that tuition inflation shouldn’t be a deal-breaker. The unfunded liabilities are typically 15 to 20 years into the future. In other words, there is still plenty of time for these plans to close the gap. Or for the state to step in. Most prepaid plans carry some form of state guarantee.
I’ve decided to go with my in-state prepaid tuition plan. What happens if my child or I don’t chose to attend that university?
As your question indicates, prepaid plans are linked to a specific state’s public schools. That means that those of you living in Illinois can invest in Illinois’ prepaid plan, which covers the average costs of tuition – in Illinois. (Only two states allow non-residents to invest in their prepaid plans: Alabama and Massachusetts.)
However, even if you don’t want to attend one of the public colleges in Illinois, your prepaid plan will not be wasted. You can transfer your investment toward the cost of any accredited college, including in-state private schools, out-of-state private and public schools, and some foreign institutions as well.
Of course, your plan will only cover the average cost of in-state, public college tuition. So, if you want to use your plan to pay for Princeton, do not expect the money to go too far.
Independent Prepaid 529 Plans
One solution to the Princeton pickle is the independent 529 Plan. Here you buy tuition certificates based on current college costs at one of America’s prestigious private universities – including Princeton, Stanford and MIT.
Over 250 of these top-tier schools have joined together to offer their future potential students an independent, prepaid 529 Plan. Just like with the state-university plans, the independent prepaid plan is flexible and can be transferred to another beneficiary or to another college within the group.
What are the tax benefits of a Prepaid 529 Plan?
With a prepaid 529 Plan, your investment will grow tax-free until its time to use it for college. Your withdrawal is also tax-free if used to fund approved educational expenses. Another tax benefit of the prepaid plan is that it reduces your state income tax by all – or a portion – of your annual investment.
Keep in mind that anyone can invest in or contribute to a prepaid plan, including parents, grandparents and even family friends. And everyone who invests will benefit from the tax-deferred savings.
Which states offer a prepaid 529 Plan?
The following states offer their residents a prepaid 529 Plan:
- Alabama***
- Colorado**
- Florida
- Illinois
- Kentucky*
- Maryland
- Massachusetts***
- Michigan
- Mississippi
- Nevada
- Ohio*
- Pennsylvania
- South Carolina
- Tennessee
- Texas*
- Virginia
- Washington
- West Virginia*
A great place to start researching your educational investment decisions is on the official website of each of these plans. The website provides fee schedules, enrollment information and application forms.
* These four states have temporarily frozen their prepaid plan to new investors.
** Colorado has permanently halted enrollment in its prepaid plan, although existing investors will still receive their tuition guarantees.
***Both residents and non-residents are invited to invest it these two prepaid 529 Plans.
How do I make the most of my prepaid tuition plan?
If you decide that a prepaid plan is the best choice for you, make the most of your investment by funding it as early as possible. This will lock in the lowest relative cost of tuition. As with any long-term investment, do not wait to make payments until the last moment. A monthly or at least annual contribution is the wise choice to maximize your plan’s pay-out.
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