Texas 529 plan offers key advantage

Question

Dear College Money Guru, I have the Texas College Savings Plan. Recently, Texas started up the Texas Tuition Promise Fund. I was thinking about switching to this prepaid plan but am unsure how it works. Can you explain how it works and do you think this would be a smart decision? -- Earl

Answer

Dear Earl,

Texans are fortunate to have the new Texas Tuition Promise Fund as a college-savings option. Only 12 other states currently offer a prepaid tuition plan to their residents.

A few states have had to close the door to new enrollments into their plans -- or shut down the programs altogether -- due to a combination of low fund investment performance and rapidly escalating tuition levels at state schools.

The new Texas prepaid program is a "unit-type" plan. To prepay one year (30 credits) of future tuition and mandatory fees at a Texas public institution, you buy 100 units. When it comes time for your child to matriculate at a Texas public institution, you simply redeem those 100 units to pay for one year.

You could buy fewer units, or more, depending on your budget and expectations regarding your child's post-secondary education.

Units come in three types: All-Texas College units, Texas 4-Year College units, and Texas Junior College units. The type you choose determines the per-unit cost as well as the future redemption value. The program offers plenty of flexibility in using units at any Texas public institution, regardless of the type initially selected.

Only through hindsight will you know if it was a smart decision to move your existing account in the Texas College Savings 529 Plan into the Texas Tuition Promise Fund. The investment return in a 529 savings plan depends entirely on the performance of the underlying funds in the investment option you've chosen, adjusted for plan-level expenses.

A 529 savings account can be used to pay qualified expenses at any eligible school in the country (and many foreign schools as well).

The "return" in the 529 prepaid plan is determined by future increases in the Texas tuition category you select, but only if your child attends a Texas public institution. Units can be redeemed for use at private colleges and out-of-state schools, but the transfer value of a unit is capped using a formula described in the plan enrollment materials. If you request a refund for any reason, the capped value is even lower.

One of the best features of the new Texas prepaid plan -- especially when compared to most other state-sponsored prepaid plans -- is that the cost of the plan is tied directly to current tuition costs.

Texas law effectively shifts the "risk" of tuition increases to Texas' public institutions, so that the program does not have to charge a premium to cover this risk.

The only other prepaid program that works in a similar manner is the Independent 529 Plan, a 529 plan operated by a consortium of more than 270 private colleges.

You could decide to keep your current 529 savings account and open a second account with the Texas Tuition Promise Fund. That way, the prepaid plan can be used to pay tuition and fees while the savings plan can be tapped tax-free to pay for room, board and books.