Prepaid plans allow you to prepay all or part of the costs of an in-state public college education, but can also be converted for use at private and out-of-state colleges. The main feature of prepaid plans is that you can lock in college costs at today’s prices and performance is typically tied to tuition inflation rates. There are three types of prepaid plans: contract, unit and voucher. Currently, only 18 states offer 529 prepaid plans and not all types are offered by each state. Educational institutions can offer their own 529 prepaid plan, but the Private College (aka “Independent”) 529 Plan, which is a prepaid plan specifically for private colleges, is the only institution-sponsored 529 plan so far.
Prepaid plans may sound great and aren’t subject to market ups and downs like 529 savings plans, but the reality is that they may not cover all costs when the time comes. While prepaid plans were historically backed by a guarantee from the state, not all are today, since ballooning tuition rates have made it very difficult for some states to keep up. Keep in mind that a state’s guarantee is only as good as its financial stability.
Savings plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments you choose from a predetermined selection. The money in your account can grow and be withdrawn tax-free if used for qualified higher education expenses, and your account value will go up or down based on the performance of the particular options you select. Nearly every state now offers a 529 savings plan option. Investment options and costs vary by plan.
Benefits of 529 College Savings Plans
Not only can 529 college savings plans help you invest in your child’s future and fund his or her education, they also offer a variety of benefits for you:
- Tax advantages. All 529 plans offer special tax benefits if used for a qualified higher education expense, such as tuition, mandatory fees, supplies, books, and room and board if the beneficiary is enrolled at least half-time. Earnings are free from federal income tax when withdrawn for a qualified higher education expense. Some states provide additional 529 state tax benefits to residents, including state income tax-free earnings for qualified withdrawals and/or state income tax deductions for contributions.
- Control of Withdrawals. A 529 college savings plan’s beneficiary does not gain control of the money. As the account owner, you will have complete control over withdrawals for the life of the account.
- Family contributions. Every holiday and birthday becomes an opportunity for family members and friends to contribute to your child’s college education.
- No income restrictions.> There is no income ceiling at which you become ineligible for opening a 529 plan account.
- Flexibility. Most 529 plans don’t have an age or time limit for withdrawals. However, you can roll over the account to another child in your family or, if you should become unsatisfied with your 529 plan, you can roll it into another state’s plan.
Impact on Financial Aid
Money stored in a 529 plan will impact your federal financial aid package, but not as much as funds stored in some other types of accounts.
When applying for Student Financial Aid (FAFSA), your family’s asset and income information is run through a specific formula to determine your expected family contribution (EFC). EFC represents the amount of money your family is considered to have available to put toward college costs for that year. Higher EFC means less financial need. Assets in a 529 plan are assessed at a maximum rate of 5.64%. This is considerably less than the 20% rate on non-529 assets owned (such as savings accounts, individual securities, investment accounts and traditional IRAs).
How Your Financial Advisor Can Help
With well over a hundred different plans available, it is easy to get confused when searching for a plan of your own. Your financial advisor can help you evaluate different 529 plans before you establish one for a child’s college fund and then review the account’s performance and suggest adjustments over time.