Prepaid college tuition pros and cons


Dear Joe,

My daughters are 3 and 5, and I would like to begin their college savings programs now. We live in Maryland, so I would like to get your thoughts on the Maryland prepaid college plan versus a standard 529. Thanks.

-- Melissa

Dear Melissa,
I presume the "standard 529" you're referring to is the savings-type 529 plan. Every state, with the exception of Washington, sponsors one or more of the savings-type 529 plans. Typically, your money is invested in a portfolio of mutual funds according to the plan option you select, and the return on your investment is determined by the performance of that portfolio over time.

A state-sponsored prepaid tuition plan is also a 529 plan, just a different type. Your return is determined by the future value of tuition benefits, not by the plan's investment performance. Only 18 states currently operate a prepaid tuition plan, and most of them (including Maryland's) restrict enrollment to families meeting certain state residency requirements.

529 savings plans offer flexibility and upside investment potential. But they can also fail to keep up with tuition increases. Some investment options may even lose value. Prepaid tuition plans provide peace-of-mind tuition protection. However, the benefits may vary depending on where your child attends college. Many parents who bought into prepaid plans years ago are very happy they did so, as tuition levels have increased dramatically at many state schools in recent years. But the deal isn't quite the same these days. Most prepaid programs have been raising their prices faster than tuition increases, to the point where you may be paying a substantial "premium" over current tuition levels.

The Maryland Prepaid College Trust is what I call a "contract" prepaid plan. You are purchasing the plan's promise to pay your child's tuition for a specific number of semesters at any of Maryland's public institutions. The contract for four-year Maryland universities is priced higher than the contract for two-year Maryland community colleges. Within either category, you gain the most benefit by having your child attend one of more expensive Maryland schools. A lower-cost Maryland public institution means less tuition benefit, although the Maryland program has provisions to ensure that you receive a certain minimum level of return. If your child attends a private college, or public institution outside Maryland, the payment made by the program is based on average tuition levels at Maryland public institutions.

A hypothetical and simplified example may help you understand how prepaid tuition plans work in Maryland and certain other states:

Full-time tuition at State U. is currently set at $8,000. Mrs. Jones purchases a one-year tuition package for son, Mark, at a cost of $10,000. (The $2,000 difference is the premium described earlier.) Fifteen years later, Mark attends State U. and the plan pays the first-year tuition bill, which by that time has grown to $25,500. Although tuition has increased at an annual rate of approximately 8 percent, the premium paid by Mrs. Jones means that her actual annual "return" is 6.5 percent. The younger the child is, the less impact the premium has.

Ohio, Pennsylvania, Tennessee and Washington offer their residents something a little different -- a "unit" prepaid or "guaranteed savings" plan. Tuition units purchased today are redeemed in the future to pay college costs. The value of a unit is based on a tuition index, typically the average tuition at public institutions in the state. One advantage of this type of prepaid plan is that you receive the same benefit, no matter where your child attends college, and you can use the money to pay for tuition and for other qualifying costs. These plans also charge a "premium" over current tuition levels. Ohio's Guaranteed Savings Fund has been closed to new enrollments since 2003.

You may also wish to consider the Independent 529 Plan, a private-college prepaid tuition plan. Open to residents of any state, this plan permits you to purchase tuition certificates redeemable after three years at any of the more than 250 participating private colleges around the country. The certificates are actually priced BELOW current tuition levels at those colleges. The pricing is reset annually on July 1, so there is still time to purchase tuition certificates at 2005-2006 prices.

Other recent questions

»Two kids, two 529 plans? (03/07/2018)
»Top 529 Plan Withdrawal Tips. (Video) (03/30/2017)
»What are the 3 biggest 529 plan myths? (Video) (03/17/2017)
»Does a 529 plan affect financial aid? (Video) (03/16/2017)
»How much does college cost? (Video) (03/15/2017)
»What Are The Top 7 Benefits Of 529 Plans? (Video) (03/14/2017)
»529s and Financial Aid (Video) (11/19/2014)
»What are the best ways to maximize the savings in my 529 plan? (Video) (10/14/2014)
»What are the steps involved in setting up a 529 account? (Video) (09/15/2014)
»What is the first step in getting started with a 529 plan? (Video) (09/05/2014)
»Coverdell ESA vs. 529 Plan: Which to choose? (Video) (07/15/2013)
»What is the best 529 plan for me? (Video) (07/10/2013)
»What happens to my 529 if my child gets a scholarship? (Video) (07/02/2013)
»Can grandparents open a 529? (Video) (06/20/2013)
»Do I have to use my own state's 529 plan? (Video) (06/12/2013)
»529 Plans: Tax Benefits of a 529 Plan (Video) (06/07/2013)
»What are the Pros & Cons of 529 plans? (Video) (05/30/2013)
»What is a 529 College Savings Plan? (Video) (05/21/2013)
»Expected addition to the the family (04/16/2013)
»Naming a successor to your 529 account (Video) (05/11/2012)
My College Savings

Help us personalize our site for you.

1. I am a ...
Please select an option.
2. My child is ...
Years Old
Please enter the age of your child.
3. I have a 529 plan for this child
Please select an option.

Reset email successfully sent.
Please check your inbox.