Despite all their faults, experts say some of the better "guaranteed" college savings plans are still good options for anyone whose kids are likely to attend participating schools.
"Prepaids can play an important role in securing the cost of a future education," says Andrea Feirstein, a longtime industry consultant who recently published a study analyzing guarantees behind the plans. "They may be the appropriate way to save if you know where your child wants to go to college," she says.
Like all "529" savings plans, the "guaranteed" plans enjoy lucrative tax breaks. Contributions to the special education accounts build up tax free as long as the money is eventually used for tuition or school supplies. (Named after the section of federal law that created them, "529s" are essentially Roth IRAs for education.) Most states also give parents a tax break on 529 contributions. "The tax benefits can increase the effectiveness of saving by between 6 percent and 39 percent depending on the tax bracket of the saver" and length of investment, a recent federal study of 529s found.
But since the recession has threatened some prepaid 529s' ability to keep their promises, Feirstein and other experts say it is crucial for parents to carve out a little time in their frazzled lives to find a safe, well-managed plan. "It's all about asking the right questions," she says.
Joe Hurley, founder of Savingforcollege.com, gives a 4½ rating (out of 5) to Mississippi's Prepaid Affordable College Tuition Program. If you don't live in Mississippi or one of the 12 other states offering a prepaid college savings plan, he also highlights the University of Alaska's ACT Portfolio, because it accepts contributions from out-of-staters. Alaska's fund promises to match the inflation rate at the University of Alaska. The university has put up enough of its own cash to make sure the fund currently has more money than it owes to future students. And the plan is comparatively generous to those who choose not to attend the University of Alaska, since it allows them to cash out their investments at market value.
Alternatively, Massachusetts's U.Plan prepaid tuition program is also open to all. Those whose children don't attend any of the 80 Bay State colleges participating in the plan can get a refund of their principal plus an amount calculated from the consumer price index.
But before parents sink any money into a 529, the experts recommend asking some important questions:
To get a quick overview of the options, check out this chart comparing the 14 prepaid plans currently accepting new investors.
Is a prepaid plan right for your family? There are two main kinds of "529" college savings plans. Washington, D.C., and every state except Wyoming offer the standard 529s, which allow parents to choose among a few state-approved mutual funds. Most states also offer simple invest-and-forget age-based plans in which fund managers for, say, the 5-year-olds are supposed to aim at achieving a big, safe payout 13 years from now (when the 5-year-old turns 18 and, presumably, heads to college).
Because of the market collapse, most standard 529 investments haven't kept up with tuition inflation. So, many parents have been attracted to plans that promise to let them buy tuition credits now and never have to worry about future stock gyrations or tuition increases. Unfortunately, as you'll see below, there's plenty of fine print, such as age and residency limitations, and questionable "guarantees" that make some prepaid tuition 529s a poor fit for many families.
Is your child likely to attend a college that participates in a prepaid plan? Ten of the 14 prepaid plans accepting new investors are limited to residents of their respective sponsoring states: Florida, Illinois, Michigan, Mississippi, Nevada, Pennsylvania, Tennessee, Texas, Virginia, and Washington. Maryland's plan is limited to residents of the state and the District of Columbia. Investors in those plans can, however, cash out their investments and use the money at nonparticipating schools in or out of state. Most plans promise to refund the equivalent of in-state tuition. But some, such as the Texas Guaranteed Tuition Plan, could return much less. Three plans accept investors from anywhere: Alaska, Massachusetts, and the Independent 529 Plan. The Independent plan allows parents to prepay tuition at more than 270 private colleges. But if the student does not enroll in a participating school, the parent can get a refund of no more than the original contribution plus a maximum profit of 2 percent a year (or a loss of up to 2 percent a year, if the markets are down).