Plan For College

Friday, April 22, 2011

Savings Plan for College Explained

If the cost of tuition in eighteen years has you worried, it should. A child born today may very well face college costs of many hundreds of thousands of dollars. Parents of prodigies aside, the rest of us may find it prudent to begin saving today. 

A popular option is the 529 plan, born in 1996 of the Small Business Job Protection Act (which, ironically, had little to do with college savings), and named after the tax code which created it. It comes in two distinct flavors, the Savings Plan and the Prepaid Tuition Plan. Here's the low-down on both:

A 529 Savings Plan offers a lineup of mutual funds (typically), which, depending on the specific plan, you choose individually, or as pre-packaged portfolios, classified by a risk level, or by your child's age. Here, you are at the mercy of the stock and bond markets, much like a 401(k) or 403(b). 

Even if you choose your plan wisely, and choose your investments wisely, you have no guarantee of success. Yet, that risk gives you the potential for significant upside growth...or loss.

A 529 Prepaid Tuition Plan allows you to lock in today's price for a state university, regardless of how high that price is later - and yes, you can buy in small increments. We've seen staggering inflation in tuition recently, which may make this seem like a no-brainer. 

But recent events have cast doubt on a state's ability - or willingness - to make good on its promise. Many states owe to parents much more than they have in the 529 bank, thanks to underperforming investments to go along with the aforementioned inflation. Alabama's plan needed a bailout, and they got it. A handful of other states guarantee the same result if necessary, but most do not.

Both have tax advantages. The Savings Plan has a tax penalty if you use the money for anything other than qualified educational expenses. But the choice between the two will likely be determined by your appetite for risk. Or you may not choose either 529 at all. Either way, make sure you get all the facts and consider you personal situation before you decide.