Q&A: 529 College Savings Plan or Prepaid Tuition Plan?

Question: Would you please explain why you prefer 529 plans over prepaid tuition plans? I ask this because I’m in Florida and have heard that Florida has among the cheapest guaranteed tuition plans. Wouldn’t it be better to lock in a guaranteed amount than to risk trying to make enough money in the market to meet the tuition costs when the kids turn 18? I’d have to come up with a lump sum for my three young children and then earn 6% a year to save enough for when they start college. Am I correct?

Ric: No, there are flaws in your reasoning.

First of all, the prepaid plan covers tuition only — not room and board, which is half the cost of college.

Second, prepaid plans require that your children attend an in-state public school. What if your child wants to go to a private or out-of state school?

And if you move to another state, your child must return to Florida to attend college — but since he or she won’t be a Florida resident, you’ll incur out-of-state tuition rates; the prepaid plans cover only in-state rates.

Also, tuition inflation has been greater than states anticipated, forcing many of them to demand more money from parents than they were told they’d have to pay. As a result, last time I checked, only 16 states still had their prepayment plans in place. The rest canceled their programs after finding that they couldn’t invest the money in a manner to keep up with the actual cost of tuition. In most cases, they gave parents their money back with only a small amount of interest, leaving many parents scrambling.

On the other hand, a 529 College Savings Plan lets you spend the money you’ve saved at any college in the nation, public or private. And it covers all college expenses — not only tuition but also room and board, books, and computers. Also, if all the money isn’t used by the child, you can let other children in the family use it. You can even hold it for use by your children’s children or their cousins. And all the withdrawals are tax-free when used for college.

As for your worries that you won’t be able to earn enough in the account, well, history says you can. The stock market has gained an average 10% per year since 1926, according to Ibbotson Associates.

For all these reasons we argue that the 529 plan gives you more flexibility and better potential than prepaid tuition plans.

Originally published in Inside Personal Finance March 2015

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