Qualified Tuition Plans (529 Plans)

Why are Qualified Tuition Plans Important?

The cost of a college education continues to skyrocket.  Between 2001 and 2011, prices for undergraduate tuition, room, and board at public institutions rose 42 percent, and prices at private not-for-profit institutions rose 31 percent, after adjusting for inflation. However, the economic benefits of a college degree are significant. For example, as shown below, the difference in lifetime earnings of an individual having a bachelors or higher degree compared to an individual with a high school degree is staggering.

My first grandchild is due in three weeks. He (they know it’s a boy) may begin at a four year college in 2031. Assume he will attend a college which costs $25,000 per year in today’s dollars. Also assume the savings will grow tax free at 5% per annum and the cost of a college education rises at 6% per annum. To meet 100% of the college costs out of savings (no scholarships, grants or aid) $725 must be invested each month until the four years of college are complete. This results in a total college cost of $312,165 or $114,518 in today’s dollars.  One critical assumption is that earnings will grow tax free.  Qualified Tuition Plans (529 Plans) are tax advantaged and all income grows tax free until withdrawn for qualified higher education expenses.

Qualified Tuition Plans are sponsored by the states or educational institutions and are authorized by Section 529 of the Internal Revenue Code.  There are two types of 529 Plans – prepaid tuition plans and college savings plans. In brief, the attributes of each are:

Prepaid tuition plans (PTP) are recognized by certain public and private institutions and have both pros and cons.

• These plans allow the purchaser (eg. parents, grandparents) to lock in future tuition and in some cases (not always) room and board at today’s prices for the beneficiary, the student. Contributions are not deductible on your federal tax return. The plans will then pay future college tuition at any of the states’ eligible colleges and universities. The PTP is structured as an advance purchase of tuition. It is not considered an investment and therefore you do not have to pick investment options. In some states your prepaid tuition may be backed or guaranteed by the state government. However, certain states have closed down their prepaid tuition programs and other states have frozen their payouts to tuition levels of an earlier period. Most states offering prepaid tuition contracts covering in-state tuition will allow you to transfer the value of your contract to private/out-of-state school. However, you may not get full value depending on the particular state. Certain states may provide incentives which either mirror the federal tax treatment or provide credits, deductions or other tax benefits.

• The tax law permits higher education institutions to offer their own 529 prepaid programs. These will allow you to target your tuition prepayment to the sponsoring institution or group of institutions.  The Independent 529 Plan is the only such program currently in operation and you must check to see what restrictions they may place on the colleges covered by the plan.

• Remember, no matter how much money you have accumulated in a PTP, the student has no guarantee of being admitted to their college of choice.

College savings plans (CSP) generally permit a college saver to establish an account for a student for the purpose of paying eligible college expenses.

• Contributions are not deductible on your federal tax return. The account grows free from federal income taxes and is not taxed upon withdrawal when used to pay qualified education expenses including tuition, room and board, mandatory fees and computers and books. Certain states may provide incentives which either mirror the federal tax treatment or provide credits, deductions or other tax benefits.  The college saver chooses from various investment options which the Qualified Tuition Plan invests on behalf of the owner of the account. These investments have market risk and therefore can increase or decrease in value. There is no age limit; it is open to both adults and children. You can start one for yourself.

• Control of a Qualified Tuition Plan is in the hands of the purchaser of the account. There can be many contributors to the account. In addition, the account can be transferred to another family member without a penalty or income tax consequences.

• The financial aid rules may change over time but the rules should be considered before determining who should be the plans’ account owner.

• Since many states have these plans there are websites which compare the various attributes of the plans to each other. Savingforcollege.com, for example, compares such things as state tax deductions, matching state contributions, account maintenance fees, investment fees, program management fees, types of investments and identifies the top performing 529 savings plans.

You need to do some analysis to decide what is right for you and your family, either a prepaid tuition plan, a college savings plan or some other investment vehicle. However, you need to do very little analysis to determine the sooner you start saving for college the better off your children or grandchildren will be.

Have you set up a 529 Plan? Which type of plan did you consider the most advantageous? What factors did you consider?

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