529 Essentials: Savings vs. Prepaid Plans

This week, we will compare and contrast 529 college savings plans and 529 college prepaid plans.

Two Basic Types of 529 plans: prepaid tuition plans and savings plans. Each state determines which plans to offer, and they are allowed to offer one type or both types of plans. Additionally, state entities have the option to not offer a plan as does happen currently with the state of state of Wyoming. While state entities are permitted to offer both types, a qualified education institution can only offer a prepaid plan. Lastly, in addition to each state determining which type of plans to offer, each plan is also somewhat unique. Therefore advisors can provide value by knowing these differences and selecting the right plan for the unique needs of their client.

Market Sizing: As of March 2016, there were 19 prepaid plans overseeing $23 billion in assets across 1.1 million accounts. Of those 19, 12 prepaid plans were open to new investors with $21.5 billion in assets across 1.0 million accounts and 7 prepaid plans were closed with $1.5 billion in assets across 0.1 million accounts. In comparison, there are 92 savings plans with $235 billion in 11.7 million accounts as of the end of March 2016. Together, 529s allow 12.8 million families to save over $258 billion in assets as of the end of March 2016.

Types of Prepaid Plans: Fundamentally, 529 prepaid plans provide families with the opportunity to pay today for tuition and specified fees tomorrow. Therefore, they allow families to prepay the future cost of college. There are generally two types of prepaid plans that get prepurchased: contract plans and unit plans. While a contract plan allows the account holder to purchase a specific number of years of tuition, a unit plan allows the accountholder to purchase a specific percentage of years of tuition. Later, when the student actually attends the qualified college and the family wants to use the contracts or units to pay for the education, the family calls the state agency that the contracts or units were purchased from and the credit gets applied to the cost of college. In terms of which colleges that the credits can be used for and which specified fees that the credits will cover, each 529 prepaid plan varies and families should review the plan disclosure statements of the plans to learn more.

Compare and Contrast:

• Market Risk: While a 529 prepaid plan locks in tuition prices and specified fees at eligible colleges, parents can lose money in a 529 savings plans as it does not lock in college costs and therefore does not protect the investor from market risk. As such, 529 prepaid plans allocate the market risk to the state entity while 529 savings plans allocate the market risk to families. This is why some investors that are familiar with the retirement industry compare 529 prepaid plans to defined benefit accounts, and 529 savings plans to defined contribution accounts.
• Advisor Compensation: Currently, no 529 prepaid plans provide a load or commission to an advisor as part of the product structure. In contrast, certain types of 529 savings plans do include a load or commission, while others do not.
• Enrollment Periods: While 529 prepaid plans have open enrollment periods, families can make contributions into 529 savings plans anytime.Payment Plans: While contributions into 529 prepaid plans are typically based on various types of payment plans, contributions into 529 savings plans can take place at any time and some have a minimum contribution level as low as $15.
• Age Restrictions: While 529 prepaid plans typically have age and/or grade school level restrictions, families can open and contribute to a 529 savings plans for a beneficiary at any age or grade level. Also while 529 prepaid plans typically have time limits on when the assets need to be used by, 529 savings plans do not have to be used within a set period of time.
• Residency Requirements: While residency requirements are much more prevalent in 529 prepaid plans as most plans require state residency of the accountowner or beneficiary, they are less prevalent in 529 savings plans. Therefore advisors and their clients should review the plan’s website and plan disclosure statements for confirmation.
• Eligible Colleges or Universities: While assets in 529 prepaid plans are typically available for certain in-state schools and programs, and for certain private schools for the Private College 529 plan, 529 savings plans can be used for the vast majority of colleges and universities in the U.S. and many abroad so long as they are eligible for financial aid from the U.S. Government.
• Qualified Expenses: While assets in a 529 prepaid plan can cover tuition and specified fees based on the plan disclosure statement, they typically do not cover room and board unless the option is specifically offered by the state entity and purchased by the accountholder. Alternatively, 529 savings plans are be used for any qualified higher education expense.

Therefore, advisors, accountants and estate planners should understand the key product features of 529 prepaid plans and 529 savings plans, how the two types of plans function independently, and more importantly how they can be used together.

Next week, we will compare and contrast 529 savings plans and Coverdell Education Savings Accounts.