Should You Invest in a 529 Plan or PrePaid State Tuition Plan?

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529 Plan or a Pre Paid State Tuition Plan?

We don’t have kids yet but in an effort to start planning early I was researching 529 plans and prepaid state tuition plans.  In just the first few minutes I realized how disadvantageous prepaid state tuition plans are and therefore shifted all my research to finding the best 529 plan instead.

The tax code provides a very good incentive to start saving for your children’s college education. This incentive is called the 529 plan in which you are allowed to invest money that will fund your child’s education in the future.  The 529 plan is a tax-exempt investment account where your money grows tax free and is also spent tax free on qualified college expenses.

What I like best about this plan is its portability.  Your child can decide to go to any college or university and you can use this plan to fund their education.  And let’s say you have two children and one gets a full scholarship to college, you can change the beneficiary on the plan from one child to another so that your other child can make use of the funds for their education.

If your second child decides school is not for him or her, no problem. You can change the beneficiary to your soon to be grandchild. I love the flexibility factor.  What was not encouraging in my research was that a lot of these plans are expensive to administer and therefore wash out the tax benefits you get from it.  Well that’s no good.

529 plans are sponsored by individual states, but they are still run by the financial services firms that run our country’s financial system.  While most plans involve high fees, there are some good ones out there that are relatively reasonable. I will come back to update once I have my list narrowed down to my top 3.  But for now let me share what I learned about pre paid tuition plans.

How are Prepaid State Tuition Plans Different from a 529 Plan?

Some states (not all) offer a pre paid tuition plan at state schools where parents are allowed to lock in or pre pay tomorrow’s tuition in today’s dollars.  They sound very attractive on the surface, but as a parent one needs to consider the solvency of the particular school or university.

Because these plans are not “portable” like 529 plans are, you loose your money if the school was to become insolvent.  Many states jumped the gun on this one and started offering them without diligently forecasting the amount it would take to fund future education.

Although the parent or child can end up loosing this game, the bigger looser is really the state because they will have to eat up the cost of funding your child’s education in the future – that is if they honor the commitment and the school you paid tuition in remains solvent.

Another big disadvantage with this plan is that parents are banking on the fact that their child will attend the school of the parent’s choice. That is not necessarily a given, especially these days when people are moving around far more than ever in the past.

Or, what happens if your child decides not to go to college? Or what if they decide to go to specific college that teaches the vocation they are interested in?

Long story short, I have opted to go with the 529 plan. I don’t know how the pre paid state tuition plans will turn out for most people already vested in them. I certainly hope the best for everyone involved.

Are you involved in either a 529 Plan or a Pre Paid Tuition Plan? Why did you pick one over the other? What do you think about it and how is it going for you?

4 Responses to “Should You Invest in a 529 Plan or PrePaid State Tuition Plan?”

1. SLee says:

   September 17, 2011 at 4:09 am

   I’m curious, why would you choose either of these plans instead of an alternative vessel of investment? Both the 529 and PrePaid State plans seem to have serious flaws. Wouldn’t it be just as good to save money for your future children’s education in a mutual fund or something like that?

   Reply
   • Sunil says:

     September 17, 2011 at 12:14 pm

     The 529 and pre paid plans have significant tax advantages, in that your investments increase over time without any tax exposure to you. Most of us truly have no idea how much we really pay in income taxes. This difference can add up to tens and hundreds of thousands of dollars, and in some cases even millions in the event your grand children and their children use it instead of your own. Have a read at the link below.

     http://easyextramoneyonline.com/blog/2010/08/effective-tax-rate/

     Saving 10,20,30 or more percent on taxes is huge over time!

     Reply
2. Anon Guy says:

   September 17, 2011 at 3:21 pm

   I went with the 529 plan for our son. Not being locked into one school or university system was the biggest factor. How do you know what college your child will want to go to when he is a toddler? With a 529 it can be used anywhere.

   SLee, with quite a few 529s you have a myriad of investment options. We have ours at Vanguard (which tends to have the lowest mutual fund and management fees) and there is a choice of over 20 funds to invest in. There are three age-based funds (which automatically changes from aggressive to conservative as your child approaches college age) and a bunch of targeted index funds (small-cap, mid-cap, etc.) plus blended funds, income, Vanguard 500, etc.

   It really is the way to go, especially with the tax picture.

   Reply
   • Sunil says:

     September 18, 2011 at 9:45 am

     Excellent summary to add. Right on the money with your synopsis. To convey easier, I often tell people to think about it like any other investment account, except tax free if used for education purposes.

     Reply