The Pros And Cons Of 529 Prepaid College Tuition Plans

By Rebecca Lake. May 7th 2016

With college tuition costs steadily increasing, more and more parents are turning to 529 plans to save for their child’s higher education expenses. 529 plans come in two distinct varieties: savings plans, which allow you to enjoy tax-free growth from your investments and prepaid tuition plans, which allow you to purchase college credits for future use at a locked-in rate. Parents who are considering a prepaid tuition plan should carefully weigh the pros and cons to determine if it’s the best investment choice for their child.

529 Prepaid Tuition Plans: The Pros

Pro #1 – More Bang For Your Buck

When you purchase tuition credits through a prepaid plan, the price is guaranteed for as long as the plan is in operation. This means that when it’s time for your child to go off to college, they’ll likely be paying a much lower rate for tuition compared to their classmates. According to FinAid.org, the average cost of tuition increases roughly 8 percent per year, with some colleges raising costs as much as 10 to 30 percent in any given year. By prepaying your child’s college costs now, you ultimately get more value for your money.

Pro #2 – Shielded From Market Volatility

529 savings plans are similar to retirement plans in that you invest your money in the stock market, typically in the form of mutual funds. When the market is up, you see a gain but when stocks fall, so does your plan’s value. With a prepaid tuition plan, the value of your investment corresponds to the amount of credits you purchase, rather than fluctuations in the market. While the assets in a prepaid tuition plan are pooled and invested collectively, ultimately, they carry a much lower risk than other types of investment vehicles.

Pro #3 – Tax-Advantaged

Parents who invest in a 529 prepaid tuition plan will also enjoy tax-free growth of their investment as long as the funds are used to cover qualified higher education expenses. According to the IRS, qualified education expenses include tuition, books, fees, room and board and equipment. This means that as long as you’re using the money for qualified expenses, you won’t owe Uncle Sam anything if the value of your investment increases over time. In addition to enjoying tax-free growth, some states may also allow you to deduct a set amount contributions on your state income taxes each year.

Pro #4 – Low Maintenance

Starting a 529 prepaid tuition plan typically requires completing a minimal amount of paperwork and setting up your regular automatic contribution plan. You don’t have to worry about choosing specific investments or monitoring your account for gains or losses. Prepaid plans eliminate much of the stress and confusion associated with other types of college savings accounts.

529 Prepaid Tuition Plans: The Cons

Con #1 – Limited Availability

One of the biggest problems associated with 529 prepaid tuition plans is that they’re not offered in every state. According to the Wall Street Journal, only 18 states currently offer some type of prepaid tuition plan. While most states allow you to invest in a 529 savings plan regardless of where you live, prepaid tuition plans are typically limited to residents of the state in which the plan is offered. In addition, some states that maintain prepaid plans are no longer accepting new participants.

Con #2 – Transferability

Prepaid tuition plans are designed to be used at public colleges and universities in the state where the plan is administered. While some plans may allow students to transfer these credits to out-of-state schools, not all of them do. Although you may be able to cash in your credits for use at a nonparticipating school, your state’s plan may limit the amount of profit you’re able to realize on your initial investment. Credits purchased through the Private College 529 plan, which allows parents to purchase tuition credits at approximately 270 private colleges and universities, may also only be used at those participating schools.

Con #3 – Not All Prepaid Plans Are Guaranteed

The basic premise of a prepaid tuition plan is that once you purchase the credits, you don’t have to worry about paying more for college if tuition prices increase. Funds contributed to a prepaid tuition plan are pooled and invested and the state uses returns from these investments to make future tuition payments at the locked-in rate. Not all states, however, guarantee that they will be able to make tuition payments on time. If there are not enough funds to cover tuition payments when it’s time for your child to go to college, the state may choose to refund your initial investment less any gains. According to Mint.com, just six states, includingVirginia,FloridaandMassachusetts, currently offer guaranteed prepaid plans.

Con #4 – Impact On Financial Aid Eligibility

Another consideration for parents is how assets held in a prepaid tuition plan may affect their child’s financial aid eligibility. Generally, prepaid tuition credits are treated as an asset of the parent and must be included on the FAFSA when calculating federal aid eligibility. As such, they can potentially affect how your child’s EFC (Expected Family Contribution) is calculated, making them eligible for fewer loans or grants. If your child applies for school-specific funding, such as work-study or school-based grants, any amount they qualify for may also be reduced in proportion to the amount of prepaid tuition credits available.

Like any type of investment vehicle, prepaid 529 plans have their advantages and disadvantages. When considering your options for funding your child’s future college expenses, it’s best to look at the full range of savings methods available to find the one that best fits your needs and expectations.

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