Should You Use a Traditional or Prepaid 529 Plan to Save for College?
When saving for your child’s college education, one of the biggest challenges is deciding between a 529 prepaid tuition plan and a traditional 529 plan. While both plans help parents save for their children’s education, the prepaid tuition plan allows them to lock in tomorrow’s tuition at today’s rates.
We’re going to take a closer look at both types of 529 plans, so you can decide which option is better for your family — specifically:
What is a traditional 529 plan?
529 plans are offered either by the state you live in or by an educational institution. You can use 529 plans to save money for a child’s college education. You choose your investment strategy and over time, the account (hopefully) grows. With regular contributions and annual returns, you can use the 529 to fund your child’s tuition and other costs.
The government and IRS incentivize you to invest in a 529 by offering you tax advantages when you set aside money for your child’s college education.
Although contributions are not tax deductible, if the money in the 529 grows, any earnings garnered will not be subject to federal tax. And as long as the beneficiary uses them for approved education expenses (like tuition or books), the withdrawals are not taxed. Students can even use 529 dollars to buy a new computer and software to use for school.
Anyone can set up a 529 for a student, even if you’re not the child’s parent or guardian. The only requirement is that you must be a U.S. citizen or an eligible noncitizen resident and be at least 18 years old. But there are contribution limits. These limits vary by state, but one universal rule is that the amount in the 529 cannot exceed the cost of the child’s education expenses.
A child can have multiple accounts set up in their name. If a grandparent, an aunt and a family friend all decide they want to open a 529 for the kid, they can all do so and have the child as the beneficiary of multiple accounts.
What is a 529 prepaid tuition plan?
With a prepaid 529 plan, you can lock in today’s tuition prices at in-state public schools for your child, even if they won’t be attending college for 10 or 15 more years. With a prepaid plan, the state guarantees the value.
For example, let’s say you purchase a semester for a public college in Florida. Today, a semester for in-state students at the University of Florida costs $6,380. In 15 years, when your child is ready to go to school, a semester at the same university could cost triple what it does today.
But because you already paid for the semester with a prepaid 529, you locked in the original price of $6,380, potentially saving thousands of dollars per semester.
Prepaid 529 plans are simpler than traditional plans and offer peace of mind, as there’s no risk of losing your principal investment. However, your child’s options are more limited. Depending on where you live, you might only get a small return on the original investment if your child decides to go to a private school or out-of-state institution.
However, if your child decides to attend another school or not attend college at all, you might be able to transfer the prepaid 529 to their sibling.
When does it make sense to opt for a prepaid plan?
Whenever you invest, there is always a measure of risk. With a traditional 529 plan, your money will ebb and flow with the stock market. As your child gets closer to needing the money to pay for school, watching the stock market’s rise and fall can get increasingly stressful and cause you to become more conservative with your investing.
A prepaid 529 can be a safer option, though it does have some risk, too. It can be a good option if you are reasonably certain your child will be comfortable attending an in-state public university. If that’s the case, a prepaid 529 can be a great investment option, helping you buy tuition at today’s prices and hedge off future tuition increases.
With a prepaid 529, your investment is secure. It is not part of the stock market, so your principal investment is not affected by any market changes. As long as your child attends a college within the state, you can use your money as you intended.
How should I save for college?
Saving for college can be challenging, but you can do so successfully if you start early and contribute regularly. By doing your research ahead of time and choosing your investment vehicles wisely, you can rest easy about your child’s education.
For more information on how to help with your children’s education, learn how to pay for college without ruining your own finances.