Understanding 529 College Savings and Prepaid Tuition Programs

For parents looking into 529 college plans to pay for their students’ education, considering the state’s financial position and understanding wise investment practices will help navigate the sometimes-murky waters of state-administered programs.

College savings plans are tax-advantaged state-administered investment programs that allow investors to save money in an account with the earnings growing free from federal income tax and, when used to pay for qualified higher education expenses, may be withdrawn federal income tax-free.

Prepaid tuition programs allow investors to purchase future tuitions at today’s rate through a contract, which transfers the risk to the state, although states differ on how they guarantee the return on these upfront payments. Parents usually make up for tuition inflation through a premium.

Across the country, state budget crises have clamped down on state universities through tuition increases, loss of scholarships and fine print that spells out a lack-of-guarantee on what some people thought were promises in 529 college savings and prepaid tuition programs. See this New York Times article on the recent Illinois disagreement over the state’s guarantees of these upfront payments.

The Alabama fund, according to the New York Times, received a bailout from the state when the 529 plan liabilities outweighed the assets, which could be an option for other states. The enrollment window for these programs varies state by state, and some states have recently closed their programs. Check out savingforcollege.com for information on your state.

For parents whose options do include 529 plans, consider the following tips to navigate the programs and invest or save wisely:

1. Read the fine print. If the investments underperform, will the state guarantee to step in to keep up with tuition inflation?
2. Understand the numbers. States like Illinois have raised tuition by an average of 10 percent over the last decade. Does the prepaid 529 plan look reasonable for your student’s enrollment year?
3. Consider the investment. Does the plan offer a blend of mutual funds or investment opportunities from one company? Do you want a more conservative certificate of deposit? Talk to a financial adviser to understand the risk, fees and other associated costs.

For parents whose faith in 529 plans has diminished – or whose state doesn’t offer them – consider these tips to save and pay for college:

1. Diversify. Any plan, whether a 529 plan or not, that puts all eggs in one basket is a risk. Don’t expect to pay for your student’s education from one fund.
2. Find private options. Look past government programs into local, regional and national private organizations that offer scholarships and grants for education.
3. Budget and plan. Approach paying for college the old fashioned way, by starting early and creating a family budget that allows for monthly saving in a money market or high-yield savings account.