A Deeper Dive into 529 College Plans

(Image credit: petrelos)

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.

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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.

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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:

Swipe to scroll horizontally

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).

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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 also happy to talk about your specific situation. Click here if you’d like to set up a complimentary consultation with me.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Deborah L. Meyer, CFP®, CPA/PFS, CEPA and AFCPE® Member, is the award-winning author of Redefining Family Wealth: A Parent’s Guide to Purposeful Living. Deb is the CEO of WorthyNest®, a fee-only, fiduciary wealth management firm that helps Christian parents and Christian entrepreneurs across the U.S. integrate faith and family into financial decision-making. She also provides accounting, exit planning and tax strategies to family-owned businesses through SV CPA Services.