Qualified tuition programs, better known as 529 plans, have become a very popular way for folks to put money away for college. These programs are run by individual states, so that means they have to meet certain requirements. What many people don’t realize, however, is that there are TWO different kinds of 529 plans. In this post, we’re going to break down the main details and differences between the two.
Two Types of 529 Plans
1. College Savings Plans
College savings plans are the drastically more popular version of the 529 plan, so we’ll cover them first. At the end of 2020, about 93% of funds held in 529’s altogether came from college savings plans. That means only roughly 7% came from prepaid tuition plans.
College savings plans favor the more risk-tolerant investor. The investment returns in these plans are based on market performance of the investments chosen. Somewhat similar to a retirement plan, 529 college savings plans have a menu of investment options to choose from. A large portion of these options tend to be “age-based allocations” that work similarly to a target-date fund in a retirement plan.
With a college savings plan, the student is typically not limited in terms of where he/she can apply. These plans also can include graduate school, not just undergraduate degrees. Since the account is not linked to any specific school or university, the investment returns are not impacted by which school the student chooses to go to. As a parent, if you are unsure what school your child will attend (which is most parents), the college savings plan definitely has the advantage in that case.
While utilizing a college savings plan gives the account more freedom and choices to work with, it also comes with more risk involved than a prepaid tuition program. With a college savings plan, you are participating in the markets, and as we all know, they can be pretty volatile. While the potential reward is greater, a more risk averse investor may want to consider the alternative.
2. Prepaid Tuition Plans
The alternative to a college savings plan is the prepaid tuition plan. Like we discussed earlier, this option is by far the less popular option. However, that doesn’t mean it should be automatically ruled out. In certain cases, these accounts can be just what somebody is looking for.
Unlike the college savings plan, prepaid tuition plans are not invested in the markets. The “investment returns” for a prepaid tuition plan come from tracking inflation of tuition prices for the school of choice. If the family knows for sure that the beneficiary will be attending a specific school, the prepaid tuition plan might be the way to go. This plan does what its name implies: it prepays the tuition for a beneficiary in the future. You are essentially paying for a school’s tuition today, but not actually attending school for years. With the costs of colleges rising every year, it *could* be smart to “lock in” your tuition costs now. However, like we discussed earlier, this only works if the beneficiary decides to go to that particular school.
Also in contrast to the college savings plans, a prepaid tuition plan may be limited to just the undergraduate years and not any graduate school years. Prepaid tuition plans are also generally restricted to tuition and other mandatory fees, but do not include room and board. A college savings plan can include room and board. The 529 prepaid tuition plan usually limits participants to those that are in-state.
As it is with the rest of personal finance, there is a lot to consider when deciding how to save for college. Hopefully this post helped clear up any confusion when it comes to 529 plans. If you have any questions at all regarding 529 plans, college saving strategies, or anything personal finance related feel free to shoot me an email – firstname.lastname@example.org.
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