When our readers and users of FreshmanFund.com send us questions, we'll post the answers here to help anyone searching for information on the best ways to save for someone's college education.
I'm considering a state pre-paid tuition plan for my child, what are the pros and cons?
Pre-paid tuition plans, also known as Prepaid Education Arrangements (PEAs), are generally more suitable for those planning on attending in-state public schools and who are closer to the attendance date. Why? These plans originated as savings mechanisms for use at states’ public university systems. While you may use these funds for private and out-of-state institutions, certain plans may not give you the full value of your investment if you do so. In addition, the investment vehicles generally used in these plans are akin to CDs or savings account 529 plans—very conservative investments. If you have a longer time horizon, other, more aggressive investment tools may be a better choice, depending on your personal investment style.
It’s one thing to look at your baby in the crib and say, “You’re going to college.” It’s another to look at that baby and say, “You’re going to State U.” How do you really know what type of school will best suit your child as an individual and as a student? Some parents know they will use the public university system regardless of other factors, be it costs, child’s desires, special majors, or other factors. For these families, a PEA may be well worth consideration.
The great benefit of a PEA is buying into the cost of college at today’s rates. This guarantee of tomorrow’s education at today’s costs is the equivalent of earning that increased value had your money been invested in a traditional investment account. In other words, you are guaranteed to earn the rate of inflation, whatever that may be, with regard to increased college costs. Another benefit of the prepaid plan is the option to purchase either a contract plan or a unit plan. Unit plans allow you to purchase tuition based on course units, perfect for a student who may be taking classes sporadically. The contract plan allows for purchase of plans by the year, from one to five years of education coverage. In turbulent economic times, the guarantee may outweigh the low returns, but the lack of flexibility remains regardless.
When making decisions about if and where your child or children may attend college, a traditional 529 offers more choice as to where these dollars may be used. Further, the PEA generally covers only tuition and fees, not the related costs of college such as books, course fees, room and board and the like. Some plans do allow for such costs in some circumstances. It is important to check the terms for the state plan you are considering before making a decision to choose a PEA over a regular 529.
The table below summarizes the pros and cons of the PEA plans:
Benefits of a Prepaid Plan
- Guaranteed to meet increased costs of state education
- Flexibility as to contract or unit plans
- Excellent for use at state universities
- Transferrable to use at private schools, but…
Downsides of the Prepaid Plan
- Lack of flexibility
- Low return on investment
- Narrow definition of covered expenses
- High penalties for withdrawal
- May not get full value if transferred for use at private school
Share your thoughts: Are you using a pre-paid tuition plan? Are you happy with it? Why is it better for your family?