529 Plans: Prepaid Tuition Or College Savings Plans

Everything You Need To Know to Choose a 529 Plan

If you're a new parent or just a loving family member who wants to help a child save for college, this post will help you navigate that process.

Over the last 20 years, the average cost of college tuition has increased by over 179% (Education Data Initiative) and is showing no signs of slowing down. As a new parent, you probably want to do everything you can to ensure your child at least has the opportunity to attend college. 529 plans offer several solutions to help you prepare for your child's future.

Saving for college doesn't have to be complicated. Let's quickly review what a 529 plan is.

What is a 529 plan?

A 529 plan is a tax-advantaged investment account designed specifically for qualified education expenses: college, K-12 tuition, apprenticeship programs, and even student loan repayments.

Unlike a traditional savings or investment account, your money can grow tax-deferred in a 529 account and any distributions used towards qualified expenses are completely tax-free (both federal and state).

Most states have their own plans with different tax benefits. You can opt for your home state or any state that accepts out-of-state enrollments.

Types of 529 Plans

There are two main types of 529 Plans. The College Savings Plan and the Prepaid Tuition Plan. We will define and compare these two types of plans below.

1) College Savings Plan (usually just referred to as a "529")

This plan works similarly to a retirement account where your after-tax contributions are invested into a portfolio comprised of the investment options the plan offers.

Benefits

• Funds grow tax-deferred

• Distributions are tax-free when used for qualified expenses

• Can be used for an array of college expenses (books, room and board, fees)

• Fully transferrable

• Any unused or leftover funds may be withdrawn by the beneficiary and used for anything (subject to a 10% penalty and taxes)

2) Prepaid Tuition Plan

Depending on your state, a Prepaid Tuition Plan may be offered. This plan lets you prepay for future college tuition (or credits) at today's prices. Prepayment may be submitted as a fixed monthly payment (5 yr, 10 yr, or more) or as a single lump sum. This can seem like an appealing option given the rising costs of tuition but there are some important considerations that you should be aware of.

Benefits

• Hedges against rising tuition costs

• If unused, you may be refunded for your payments

• Transferrable to eligible, out-of-state institutions (although the amount will be equivalent to the rate of tuition in the state you purchased it in)

Is Prepaid Tuition a Good Idea?

A Prepaid Tuition Plan can be an excellent idea for saving for college. However, it may not be the best way for your situation. Before opting for a Prepaid Tuition Plan, you should be aware of these considerations:

• Missed Opportunity: Since your money isn't invested, you miss out on the potential growth of your money if it were invested in a College Savings Plan.

• Restricted Use: The plan often only covers tuition but excludes expenses like room and board, books, and more.

• Limited Transferability: States may only allow you to transfer to another family member for a designated period of time.

Which is better a 529 or Prepaid Tuition?

Disclosure: This is not investment advice and I am not a financial advisor.

Everybody's situation varies but generally speaking, I think the 529 College Savings Plan is the superior option for those saving for their child's future. To illustrate the biggest difference between the two, see the example below using Nevada's Prepaid Tuition Plan as the subject.

In 2001, a prepaid tuition plan cost $13,680.00. If you opted for the 5-year payment option, you would have made 60 monthly payments of $228. In 2020, the cost of tuition at UNLV was $26,415. That's a total savings of $12,735!

However, let's say you instead invested that same money into a 529 plan. For 5 years, you invested $228 a month. Your cost would have been exactly the same but in the end, you would have had $49,416.67 when your child started enrolled in college in 2019*. That means your child would have had an extra $23,001.67 which could be used for all those additional expenses or, it could be seed money for a home, car, or for their own business venture.

Are 529 accounts a good investment?

To determine if a 529 account is a good investment, let's first establish a few factors.

1. Traditionally, the US stock market returns 8% annually.

2. If the cost of tuition continues to increase at the current rate, the cost of attending UNLV (for 4-years) will be $59,317.89 in 2044.

3. Today, the Nevada Prepaid Tuition Plan calls for 5 years of payments at $478/month.

If you opt for a Nevada Prepaid Tuition Plan, you would have only paid $28,680.00 for a 4-year degree that otherwise would have cost $59,317.89, saving you $30,637.89.

If you opt for a 529 plan and invest the same amount of money over 5 years, your money can grow to $102,412.72. Even with the increased tuition, that still produces an additional $43,094.82 for your child.**

Where can I open a 529 plan?

Saving for college is one of the biggest concerns for parents. 529 Plans, either as College Savings Plans or Prepaid Tuition Plans offer great tools for tackling this daunting task. To start a 529 Plan today, I recommend using Fidelity. Accounts are free, have no minimum to get started, offer low-fee investment funds, and allow for automatic investments on your own schedule.

If you have additional questions about a 529 Plan, feel free to reach out to us at info@themoneycrab.com

*Calculation was based on the performance of a portfolio invested 100% in US stocks (using the Vanguard Total Stock Market Index Fund - VTSMX) during the referenced time period.

**Projection based on a portfolio 100% invested in US stocks with an annual return of 8% and with fund fees already subtracted.