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RSS FeedWhat type of 529 plan is better, prepaid or savings?
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| Prepaid | 35% | 9 votes | Total: 26 votes | |
| Savings | 65% | 17 votes |
Prepaid
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Add to FavoritesHaving saved for my children's education both ways, I can say with no hesitation that a prepaid plan is the best way to go. The difference is pretty simple. There are tax issues with both, and I'm pretty sure they will vary from state to state.
With a 529 Savings Plan, you make deposits into a plan you have set up in both your name and your child's name. The money is invested and can either gain or lose money depending on the market. The amount you deposit is up to you. You can have automatic withdrawals or send checks or both. This makes it easier if your income isn't steady or if your budget is tight. You can open a 529 Savings Plan anytime you are ready.
With a prepaid program you pay the average cost of four years of instate tuition based on the tuition cost of the year you enroll your child. The earlier you start, the better it is all the way around. Tuition only goes up, and the longer you have to pay for it the smaller your monthly obligation will be. I can't say about other states, but here in Michigan you can only enroll in the MET (Michigan Education Trust) program at certain times, and I don't believe that it opens up every year.
We started late, when our oldest son was in the fifth grade. It was really hard on us financially, so we simply were not in a position to enroll our two younger children in the program. We were essentially paying three private school educations, my college tuition, and our oldest sons college tuition at the same time.
But now, he is a Junior at Central Michigan University and all we've had to pay is his room and board and books. Current instate tuition is $9720 per year. We paid for all four years of his undergraduate education for under $20,000. Essentially, we are getting his education for about half price.
We opened 529 Savings plans for each of our other two children. Because we were not forced to pay a certain amount each month like we were with the MET we had for our oldest, and because we were stretched so tight, the plans never grew like we had hoped. We cashed in our son's plan last year when he started attending Oakland University. It paid for almost a semester.
Our daughter's 529 plan will be cashed in soon, as we will be sending Western Michigan University tuition payments starting in a few months. It's a good thing, too. In 2008 alone that 529 lost $760. It is tied to the stock market, remember?
If I had to do it over again, I would have enrolled all three of them at the earliest possible date. It would have been difficult at the time, but now, it would all be behind me. As it is, I can look forward to many more years of college tuition.
Learn more about this author, Kelly Szymanski.
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Savings
Section 529 of the Internal Revenue Code allows a donor to invest money for the future higher educational needs of a beneficiary with significant tax incentives for doing so. Federal income tax on the gains of a 529 Account is deferred and distributions for qualified educational expenses are entirely tax-free. In addition, many states offer similar income tax treatment and some even offer additional grants and other benefits. Currently, these accounts are only available through a state or through particular participating institutions.
There are two distinct types of 529 Accounts, prepaid plans and savings plans. Prepaid plans allow a donor to purchase tuition credits at a specific institution or good for any state-run institution in a particular state. Savings plans allow a donor to invest in mutual funds, growing a pool of money from which educational expenses can be paid. A good analogy to distinguish between the two types of 529 plans is that they are like retirement plans; the prepaid plan is similar to a pension and the savings plan is similar to an IRA.
A prepaid plan offers the donor a defined benefit, a number of credit hours per dollar spent. This type of plan is advantageous for the donor who wants the school or state to have total control of the money when donated and who knows that his beneficiary only wants to go to a certain college (or a public college in a certain state).
The savings plan, on the other hand, is typically the better choice in that it is far more flexible and should outperform the prepaid plan in terms of purchasing power. Savings plans are only offered by states (not institutions), but allow a donor to invest in mutual funds, often mutual funds managed by private companies. This gives the donor a say in how the money is to be invested, based on their personal tolerance for risk. Alternatively, donors can often choose a target-date fund, which invests in high-risk, high-return securities initially and gradually shifts to low-risk investments as the beneficiary's enrollment date nears. The flexibility of a savings plan is even more valuable when it comes time for a disbursement. Money invested in a savings plan can be spent at any college in any state. It can also be spent on books, housing and other qualified expenses.
Savings plans should also outperform prepaid plans. By purchasing prepaid credit hours, a donor is merely insuring against inflation. For example, the donor is buying a credit hour in 2018 for the price of a credit hour in 2008. However, financial markets have historically outpaced inflation over time. Given current the current poor economy, the further in time the beneficiary is expected to attend college, the greater the likelihood that a savings plan will still be more financially sound than the prepaid plan. Therefore, unless the beneficiary plans to attend college within the next two years, the savings plan is the best financial bet.
While any 529 plan is better than simply putting money aside for college, savings plans are generally the best bet for educational savings. Savings plans are flexible, both in terms of investment strategy and in terms of their eventual use. They are also more likely to outperform prepaid plans. Although prepaid plans are preferable under certain circumstances, a savings 529 plan is the all-around better choice.
Learn more about this author, Bradley Streeter.
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