By Mary G. Morris
October 1, 2013
“Why should I save for college with a prepaid tuition plan? My financial advisor said I should invest in a 529 plan instead.” Many of us in the 529 world frequently hear this from families who are exploring their college savings options. Our response is always the same, “A prepaid tuition plan IS a 529 plan, and there are some important benefits to saving for college with one.”
For those unfamiliar with 529 plans, they come in two distinct types – “college savings plans” and “prepaid tuition plans.” All 529 plans share common features such as federal income tax exemptions on earnings and withdrawals and most offer the ability to pay for college expenses at nearly any accredited college in the country. The primary difference between the two is that “savings plans” are investment accounts similar to any other investment that may increase in value over time, while “prepaid plans” allow families to prepay all or some portion of future tuition and fees, no matter how much tuition increases in the meantime.
Prepaid tuition plans have unique features not found in other 529 plans. Known in some states as guaranteed savings plans, prepaid plans combine lower, or no, risk with higher potential growth rivaled by no other way to save for college. Many prepaid plans also have special state guarantees or protections not offered in 529 savings accounts.
Only twelve states currently offer prepaid plans and their structures and benefits vary. Because of the unique state protections, most prepaid plans have residency restrictions, making a decision about investing a state specific choice. If you live in any of the 12 following states, you should check out your prepaid tuition plan and see if it is the right choice for you: Alaska, Florida, Illinois, Maryland, Michigan, Mississippi, Massachusetts, Nevada, Pennsylvania, Texas, Virginia, and Washington.
More than 1.3 million prepaid accounts exist nationwide, valued at nearly $22 billion. Prepaid tuition plans already have helped tens of thousands of students pay for college, with downside protection important to many families during a time of unprecedented market volatility. Because of recent challenging investment markets, and college costs increasing faster than inflation, and some challenges to some prepaid plans, they have been the subject of national media attention.
In particular, those stories focus on the “underfunded” status of some programs. What does “underfunded” mean? Here is where 529 prepaid tuition plans get a bit harder to understand. The term is an actuarial one which provides a point in time snapshot view of a program and its long-term prospects. So, if current plan assets are less than projected future obligations when a valuation is done, it is considered underfunded – whether by one percent or more, and that determination is based on actuarial assumptions about projected investment returns and tuition inflation. AND, it assumes that all of the projections will be realized exactly. In fact, the projections can fluctuate significantly and impact the program, for better and worse – and the funded status alone does not tell the whole story. What is important is how the plan is managed by the state and whether they are proactive in assessing and reacting to changing conditions.
Of the twelve state-sponsored prepaid tuition plans that remain open for new investors, the majority are fully funded (again, on an actuarial basis). Some prepaid plans did choose to close to new investors – some many years ago and some more recently. The reasons for closing are unique to those states and plans, but they did so in order to live up to promises to those already in the program.
The states with open prepaid plans have weathered economic and college cost volatility through two recessions and offer a unique benefit to the citizens of their states. If you live in or the student you are saving for lives in a state that offers a prepaid plan, it could be the right solution for you. You should do your research, read the valuation reports for your state’s plan, understand the benefits and promises offered by your state and make your decision.
But remember that a prepaid program is not the only way that you may save for college. Even if a prepaid plan is right for you, it may not be the entire solution and you may want to consider using a college savings plan as well.
To learn more about a specific 529 prepaid tuition plan, check out our plan comparison tool. In addition, go to www.collegesavings.org for unbiased information about all 529plans, prepaid and savings, and learn more about the importance of planning and saving for the future cost of higher education and the ways a 529 plan can help.
About the Author:
Mary G. Morris is CEO of Virginia529, the independent state agency which sponsors Virginia’s four tax-advantaged 529 college savings programs, including a prepaid tuition program, two direct-sold savings programs and one adviser-sold savings program. As of November 30, 2012, Virginia529 has more than $43.45 billion in assets under management across its four programs in over 2.3 million active 529 accounts across the country. Morris serves as a member of the Executive Board of the College Savings Plans Network (CSPN) and Co-Chair of the CSPN Federal Initiatives Committee. For more information about Virginia529, visit Virginia529.com or call toll-free at 888-567-0540.