Should You Use a Traditional or Prepaid 529 Plan to Save for College?

529 plan

When you have a child, saving for college can be overwhelming. Besides finding the money to set aside each month, you also have to learn all the terminology to help your child to go to school. From FAFSA deadlines to Pell Grants, there’s a lot to keep in mind.

One of the biggest challenges is deciding what kind of 529 college savings plan to use. While most people have heard of the traditional 529 plan, there are actually two types of 529 plans available. Your other option is a prepaid 529 plan, which many may not be familiar with.

Below, find out more about what each 529 plan offers.

What is a traditional 529 plan?

529 plans are offered either by the state you live in or by an educational institution. You can use 529 plans to save money for a child’s college education. You choose your investment strategy and over time, the account (hopefully) grows. With regular contributions and annual returns, you can use the 529 to fund your child’s tuition and other costs.

The government and IRS incentivize you to invest in a 529 by offering you tax advantages when you set aside money for your child’s college education.

Though contributions are not tax deductible, if the money in the 529 grows, any earnings are not subject to federal tax. As long as the beneficiary uses them for approved education expenses like tuition or books, the withdrawals are not taxed.

As of 2010, students can even use 529 dollars to buy a new computer and software to use for school.

Anyone can set up a 529 for a student, even if you are not the parent or guardian of the child. The only requirement is that you must be a U.S. citizen or resident alien and be at least 18 years old. But there are contribution limits; the amount in the 529 cannot exceed the cost of the child’s education expenses.

A child can have multiple accounts set up in their name. If a grandparent, aunt, and family friend all decide they want to open a 529 for the kid, they can all do so and have the child as the beneficiary of multiple accounts.

What is a prepaid 529 plan?

With a prepaid 529 plan, you can lock in today’s tuition prices at in-state public schools for your child, even if he or she will not be attending college for 10 or 15 more years. With a prepaid plan, the state guarantees the value.

For example, let’s say you purchase a semester for a public college in Florida. Today, a semester for in-state students at the University of Florida costs $6,380. In 15 years, when your child is ready to go to school, a semester at the same university may cost triple what it does today.

But because you already paid for the semester with a prepaid 529, you locked in the original price of $6,380, potentially saving thousands of dollars per semester.

Prepaid 529 plans are simpler than traditional plans and offer peace of mind, as there’s no risk of losing your principal investment. However, your child’s options are more limited. You can only use prepaid 529 plans at in-state public schools. If they want to attend school out-of-state or look at private schools, they lose out on your funds.

However, if your child decides to attend another school or not attend college at all, you can transfer the prepaid 529 to another beneficiary.

When does it make sense to opt for a prepaid plan?

Whenever you invest, there is always a measure of risk. With a traditional 529 plan, your money will ebb and flow with the stock market. As your child gets closer to needing the money to pay for school, watching the stock market’s rise and fall can get increasingly stressful and cause you to become more conservative with your investing.

A prepaid 529 can be a safer option, though it does have some risk, too. It can be a good option if you are reasonably certain your child will be comfortable attending an in-state public university. If that’s the case, a prepaid 529 can be a great investment option, helping you buy tuition at today’s prices and hedge off future tuition increases.

With a prepaid 529, your investment is secure. It is not part of the stock market, so your principal investment is not affected by any market changes. As long as your child attends a college within the state, you can use your money as you intended.

Saving for college

Saving for college can be challenging, but you can do so successfully if you start early and contribute regularly. By doing your research ahead of time and choosing your investment vehicles wisely, you can rest easy about your child’s education.

For more information on how to help with your children’s education, learn how to pay for college without ruining your own finances.

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Published in Smart Tips for Saving Money

  • nancyfarmer

    Kat, your discussion of prepaid tuition contains a glaring omission – a nationwide plan owned by nearly 300 private colleges and universities. (Think Princeton to Stanford and everything in between) Private College 529 Plan, of which I am president, allows families to buy future tuition at any member school at today’s prices. The schools guarantee the prepaid tuition no matter how much tuition increases, what happens in the stock market, or what state legislators do with their budgets, so our account owners are protected from market downturns. Furthermore, families pay no fees. Member schools cover the costs. This is a good option for families who may want to look beyond their own state schools for prepaid tuition.

    • Kat Tretina

      Hi Nancy, thanks so much for sharing this information. I will look into this–and reach out to you–to get more information to potentially include in a future article.