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COLLEGE SAVINGS 101

Is there a prepaid 529 plan in your future?
http://www.savingforcollege.com/articles/is-there-a-prepaid-529-plan-in-your-future

Posted: 2009-03-20

by Joseph Hurley

Prepaid college plans have attracted a lot of press lately some good, some not so good.

Some articles have extolled their benefits and recommended them as a safe alternative to underperforming 529 savings plans. Other articles have warned that prepaid plans are running out of money and may not be able to deliver the benefits promised to their participants.

Here's some help in figuring it all out:

What is a prepaid plan?

A prepaid plan is a program that allows you to pay money now to be used for future college expenses. Prepaid plans come in several forms, and in comparing plans you will find many differences. For example, some prepaid plans cover tuition and fees only, while others cover all qualified higher education expenses. The essential benefit is that you lock in those costs: Once you've paid the plan's price, it becomes the obligation of the plan to deliver the promised benefits down the road.

Savingforcollege.com groups prepaid plans into three categories:

  • "Contract" plans These allow you to prepay tuition for a number of semesters or years at an in-state, public, four-year or two-year institution. (Think futures contract.)

  • "Unit" plans These allow you to purchase fractional units (typically 1 percent of one-year's tuition) that are redeemable in the future based on average tuition rates at a target group of schools. (Think tuition index fund.)

  • "Voucher" plans These allow you to prepay a specified percentage of tuition at participating schools. (Think percentage-off coupon.)

Where do you find them?

Twenty states operate prepaid plans. Of these, 19 are 529 plans. The Massachusetts U.Plan is a prepaid plan that is not a 529 plan, which means that none of the special 529 rules applies to its participants. That can be good or bad, depending on the particular rule. The U.Plan utilizes Massachusetts general obligation bonds, so the earnings are federally tax-free whether or not used for college. For Massachusetts residents, the earnings are also state-tax free.

In addition, there is one non-state-sponsored 529 plan: a consortium of private colleges, located across the country, operating a prepaid tuition plan called the Independent 529 Plan. Your prepaid dollars can be used at any of the member colleges.

Of the 21 prepaid plans, only 15 are accepting new applicants. The rest have closed enrollment more or less permanently and exist only to pay benefits for their current participants.

Of the 15 plans still open, 11 have state residency requirements. Anyone can use the other four, although you would most likely consider joining one of these four plans only if you expected your child to attend a certain college or one of a certain group of colleges.

Should you use a prepaid plan?

First, look to see if your state even offers a prepaid plan. (If your beneficiary lives in a different state, look there also.) The Independent 529 Plan (274 private colleges), the U.Plan (80 public and private Massachusetts colleges), or the University of Alaska College Savings Plan may be of interest if you have a good idea where your beneficiary will be attending college.

Then, learn the particulars of the prepaid plan by carefully reading its official enrollment materials. Much like a health insurance plan, it's important to understand the benefits of going to an "in-network" college (one that is specifically covered by a plan) and the conversion formula used for attendance at an "out-of-network" college (a college not specifically covered by that plan.).

You can also evaluate the 21 prepaid plans in five different categories by using the comparison chart below.

Naturally, you'll make out better in a financial sense if tuition rises dramatically after you pay in to the plan. But be sure to compare the price you pay to current tuition levels many prepaid plans charge a substantial premium over current tuition in an attempt to stay fiscally sound. The premium is an extra cost that may take years of tuition hikes to overcome.

Finally, go through the "what if" exercise. Ask yourself about every eventuality you can think of, such as:

  • What if your child takes more credits, or fewer, than the standard load?
  • What if your child attends college on a scholarship, or doesn't attend at all?
  • What if your family moves out of state and your child is no longer eligible for in-state tuition rates?
  • What if in-state tuition goes down, not up?
  • What if you sign up for an installment payment plan but lose your job and cannot afford the installments?

Another big "what if" concerns the plan's ability to stay in business. How long can it afford to pay ever-increasing tuition rates if its returns on invested contributions don't keep pace? The "funding ratio" in several prepaid plans has dropped precipitously over the past year with the collapse of the stock market, and actuaries have determined that some plans will run out of money in the future if conditions don't change.

Some prepaid plans have a better "backstop" than others do. Some states attach their full faith and credit to their prepaid plans while others offer only a "legislative guarantee" that an appropriation will be considered. A few plans shift the risk of underperforming investments to educational institutions by asking (or requiring) that they accept less tuition for plan participants if the investments don't keep up. The prepaid plans in the most exposed position are those without any state backing or legislative guarantees, so that they must rely entirely on plan investments to pay out future obligations.

Plan Residency requirements? Type Out-of-network benefits Backstop Enrollment period
Plans accepting new enrollment:
Prepaid Affordable College Tuition (PACT) Program No Contract Average in-state tuition Fund assets only October thru December
University of Alaska College Savings Plan No Unit Contributions plus/minus portfolio performance Direct obligation of state Year-round
Florida Prepaid College Plan Yes Contract In-state tuition Full faith and credit October thru January
College Illinois! 529 Prepaid Tuition Program Yes Contract Average in-state tuition Legislative guarantee October thru April
Independent 529 Plan No Voucher Contributions plus/minus fund performance (2% annual collar) Commitment by colleges Year-round
College Savings Plans of Maryland - Prepaid College Trust Yes Contract Average in-state tuition Legislative guarantee December thru March
Massachusetts U.Plan No Voucher Contributions plus interest (at CPI) Full faith and credit May thru June
Michigan Michigan Education Trust Yes Contract Average in-state tuition Fund assets only Year-round
Mississippi Prepaid Affordable College Tuition (MPACT) Program Yes Contract Average in-state tuition Full faith and credit September thru December
Nevada Prepaid Tuition Program Yes Contract Average in-state tuition Fund assets only January thru April
Pennsylvania 529 Guaranteed Savings Plan Yes Unit Same as in-network Fund assets only Year-round
Tennessee's BEST Prepaid College Tuition Plan Yes Unit Same as in-network Fund assets only Year-round
Texas Tuition Promise Fund Yes Unit Contributions plus fund performance Statutory requirement on in-state public September thru February
Virginia Prepaid Education Program (VPEP) Yes Contract Lesser of in-state tuition or contributions plus interest/fund performance Legislative guarantee December thru March
Washington Guaranteed Education Tuition (GET) Yes Unit Same as in-network Full faith and credit September thru March
Plans closed to new enrollment:
Colorado Prepaid Tuition Fund Unit Same as in-network Fund assets only
Kentucky's Affordable Prepaid Tuition (KAPT) Contract/unit Contract payout value State unclaimed property fund
Ohio CollegeAdvantage - Guaranteed Savings Fund Unit Same as in-network Fund assets only
South Carolina Tuition Prepayment Program Contract Lesser of average in-state tuition or contributions plus fund performance Legislative guarantee
Texas Guaranteed Tuition Plan Contract Average in-state tuition Full faith and credit
West Virginia SMART529 Prepaid Tuition Plan Contract Average in-state tuition State unclaimed property fund

Prepaid college plans have attracted a lot of press lately some good, some not so good.

Some articles have extolled their benefits and recommended them as a safe alternative to underperforming 529 savings plans. Other articles have warned that prepaid plans are running out of money and may not be able to deliver the benefits promised to their participants.

Here's some help in figuring it all out:

What is a prepaid plan?

A prepaid plan is a program that allows you to pay money now to be used for future college expenses. Prepaid plans come in several forms, and in comparing plans you will find many differences. For example, some prepaid plans cover tuition and fees only, while others cover all qualified higher education expenses. The essential benefit is that you lock in those costs: Once you've paid the plan's price, it becomes the obligation of the plan to deliver the promised benefits down the road.

Savingforcollege.com groups prepaid plans into three categories:

  • "Contract" plans These allow you to prepay tuition for a number of semesters or years at an in-state, public, four-year or two-year institution. (Think futures contract.)

  • "Unit" plans These allow you to purchase fractional units (typically 1 percent of one-year's tuition) that are redeemable in the future based on average tuition rates at a target group of schools. (Think tuition index fund.)

  • "Voucher" plans These allow you to prepay a specified percentage of tuition at participating schools. (Think percentage-off coupon.)

Where do you find them?

Twenty states operate prepaid plans. Of these, 19 are 529 plans. The Massachusetts U.Plan is a prepaid plan that is not a 529 plan, which means that none of the special 529 rules applies to its participants. That can be good or bad, depending on the particular rule. The U.Plan utilizes Massachusetts general obligation bonds, so the earnings are federally tax-free whether or not used for college. For Massachusetts residents, the earnings are also state-tax free.

In addition, there is one non-state-sponsored 529 plan: a consortium of private colleges, located across the country, operating a prepaid tuition plan called the Independent 529 Plan. Your prepaid dollars can be used at any of the member colleges.

Of the 21 prepaid plans, only 15 are accepting new applicants. The rest have closed enrollment more or less permanently and exist only to pay benefits for their current participants.

Of the 15 plans still open, 11 have state residency requirements. Anyone can use the other four, although you would most likely consider joining one of these four plans only if you expected your child to attend a certain college or one of a certain group of colleges.

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