A college degree is often seen as a stepping stone to a better career. Yet, the costs of that degree are often growing at an unbelievable rate. A 529 plan can be a great way to save for college. However, there are two types of 529 plans: savings and prepaid tuition.
The first type of 529 is an investment account. You add money to your account and invest it in a variety of different mutual funds. All 50 states offer these 529 plans, and they are often more flexible because you can use the money for most qualified college expenses including tuition, room and board and textbooks.
Prepaid tuition plans
The second option is a prepaid tuition 529 plan. With these plans, you prepay for semesters of college tuition at today's rates. This locks in the price so you don't have to worry about college tuition going up in the future. These plans are more restrictive and not all states offer them. You need to be aware that these types of 529 plans only lock in the tuition at schools listed on the plan. If your child attends a school that isn't on the list, you'll be able to transfer over the value of your account, but there's no guarantee that it will be enough to cover the full cost of tuition. Also, the prepaid plan in your area may not be able to be used for expenses beyond tuition, such as textbooks or room and board. Be sure to investigate plans in your area thoroughly if this is an option you're considering.
The primary differences between the two types
College Savings Plan
- No lock on college costs.
- Covers all "qualified higher education expenses," including:
- Room & board
- Mandatory fees
- Books, computers (if required)
- Many plans have contribution limits in excess of $200,000.
- No state guarantee. Most investment options are subject to market risk. Your investment may make no profit or even decline in value.
- No age limits. Open to adults and children.
- No residency requirement. However, nonresidents may only be able to purchase some plans through financial advisors or brokers.
- Enrollment open all year.
Prepaid Tuition Plan
- Locks in tuition prices at eligible public and private colleges and universities.
- All plans cover tuition and mandatory fees only. Some plans allow you to purchase a room & board option or use excess tuition credits for other qualified expenses.
- Most plans set lump sum and installment payments prior to purchase based on age of beneficiary and number of years of college tuition purchased.
- Many state plans are guaranteed or backed by state.
- Most plans have age/grade limit for beneficiary.
- Most state plans require either owner or beneficiary of plan to be a state resident.
- Most plans have limited enrollment.
Source: Smart Saving for College, FINRA®
NOTE: As of 2018, the IRS has amended the term “qualified higher education expense” to include a limited amount of annual expenses from a 529 Plan for tuition at an elementary or secondary public, private, or religious school. Source: www.irs.gov/newsroom/529-plans-questions-and-answers.