De-mystifying 529 Prepaid Programs

By Mary G. Morris,
CEO, Virginia529
May 5, 2014

After deciding on a 529 plan for their college savings, one of the first questions asked by many families is “savings plan or prepaid tuition plan?” (For a basic overview of the two, read “What is a 529 Plan?” on this website.) While savings programs are relatively straightforward, prepaid tuition programs suffer from many misconceptions, perpetuated by people who don’t fully understand their benefits.

The 13 prepaid tuition programs available in the U.S. offer customers a hedge against future tuition inflation that can’t be realized through savings programs.

In general, prepaid programs tend to be state-specific (or coverage-specific), have some age, residency and/or use restrictions and offer a defined benefit in the form of future tuition and fee coverage at participating schools. Although every prepaid program allows benefits to be applied to non-participating schools without loss of principal, the total value of an account may vary depending on where it is used.

Some prepaid naysayers focus on prepaid program restrictions and insist savings program returns are better. This criticism misses the point – prepaid programs offer peace of mind about the ability to cover the future cost of tuition at covered or participating schools regardless of what happens to tuition inflation OR the financial markets. The true value of a prepaid account is that they all offer some type of promise by the sponsoring state (or colleges) that there will be no loss of principal and that the investment or contract will cover the promised tuition benefit in the future. Principal protection is key in a prepaid program.

Much has been written about the value of the prepaid promises. Some are virtually airtight – three states (Massachusetts, Mississippi and Washington) back their prepaid programs with a “full faith and credit pledge” which a state is constitutionally required to honor. Four states (Florida, Illinois, Maryland and Virginia) provide a statutory or legislative guarantee – which means state statutes provide for funding of prepaid benefits in case of any future shortfall. The remaining states secure their prepaid obligations with a combination of the fund itself and the promises of participating colleges.

The reality is that, through two recessions, no state has walked away from its prepaid obligations or failed to ensure that all or most benefits were paid and no investor has lost principal in any prepaid program Of the prepaid programs currently open to new investors, not a single one has ever even contemplated not meeting its current and future obligations in full. For many, a prepaid 529 is the right way to go. As with any investment, do your research and decide what works best for you and your family.