Terms to Know
Prepaid Tuition Plans- Families are able to pre-purchase credits at public, in-state universities at grandfathered rates. These credits can be counted to tuition costs, but generally not room and board. While these plans are not guaranteed by the federal government, they are often guaranteed by the state government. If the plan is not guaranteed by the state government, families may lose money in the case of the sponsor’s adverse financial circumstances. These plans are also tied to specific eligible schools, so if the beneficiary does not attend participating institutions, they may receive less in tuition payments and so there is less value in using a prepaid tuition 529 plan.
College Savings Plans- These investment accounts allows students to assign savings to eligible higher education costs such as room, board, and tuition. Unlike prepaid tuition plans, these savings can be used at a wide range of institutions such as graduate schools, foreign schools, private schools, and out-of-state schools. Not all college savings plans are created equal, as some are riskier than others. The saver can choose investment options such as exchange-traded funds, principal-protected bank product, or mutual funds. With static fund portfolios, the asset choice remains the same unless the saver decides to reallocate. This is a good option for families who are planning to use the funds in the near future. Age-based portfolios are particularly popular for younger savers will use a riskier mix with stocks. It’s great for families who are less investment-savvy. Unlike prepaid tuition plans, all college savings plans are sponsored not guaranteed by the state and most have no residency requirements. The investments in exchange-traded funds and mutual funds are not guaranteed by the federal deposit insurance corporation, but some principal-protected bank products are. As all investments go, there is always a risk the saver may lose money in the end.
Benefit Analysis
Prepaid Tuition Plans- These plans are ideal for savers who are certain where they will attend and that the school is one of the participating institutions. They will likely be able to receive the greatest ROI for that school of any plan.
College Savings Plans (all)- Earnings from college savings plans develop on a tax-deferred basis. Unlike standard brokerage accounts, there are no taxes paid on interest, capital gains, or dividends. Depending on the state, the saver may be able to deduct their contributions on their incomes taxes. For all related costs, funds may be deducted tax free (earnings do not qualify as they are subject to penalty fees and income taxes). The account owner (often a parent) can change the beneficiary at any time (often to a sibling, but always to another family member).
College Savings Plans (age-based/target-date portfolios)- These plans are ideal for younger savers as they allow you to set and forget the plan while using an aggressive risk-reward formula.
College Savings Plans (exchange-traded funds)- These plans are ideal for risk-averse savers as they offer increased diversification and extra protection from volatility.
College Savings Plans (mutual funds)- These plans are ideal for most savers and are most popular. They are a good balance between risky enough to reap high rewards and diverse enough to feel comfortable in the investment’s returns.
College Savings Plans (principal-protected bank product)- This is a very safe option and allows for simple withdrawals at random.
Further Resources