What’s the best option for saving for college? This is a question that many parents, both first timers as well as the experienced, are facing today. There are basically two types of products available to address this issue. On one side we have state-sponsored college savings plans, like Florida Pre-paid. On the other hand are investment type plans which can be either be Coverdell Education Savings Account or 529 Plans. Each have their pro’s and con’s. Bottom line, parents need to do their research before deciding which plan they will feel most comfortable with moving forward.
State Sponsored Plan aka Florida Pre-paid
State sponsored plans like the Florida Pre-paid have become very popular in recent times. States market the plan as a “tax-free, risk-free, worry-free way to save for college” (myfloridaprepaid.com). Just by reading that introduction, it’s easy to see why it has such a popularity. Let’s look at some of the pros and cons.
Pros: State-sponsored plans offer a “lock in today prices” concept which attracts many prospective participants into the plan. This concept is geared towards combating the inflation aspect to college tuition. Current in state tuition for Florida Universities is $2569 tuition, $10,120 R/B, $1030 books and $1904 fees totaling $38,748. According to collegebaord.org, inflation impacted college tuition by an average of 3.2% from 2007-2017. The plan states that even if college tuitions prices increase more than your account value, the plan will pay. The plan participant will never lose money. Additionally, these plans are not tied to investment vehicles meaning the account value will not fluctuate during times of financial market instability. The current plan offerings have expanded and the required monthly contributions were considerably reduced with the passage of House Bill 851 in 2014.
Cons: With that said, prepaid plans often are saddled with some restrictions. Example: Florida prepaid plans are applicable to Florida’s public university system – meaning that their full value can only be used at the public colleges and universities in Florida (Erin Spiwak – James Moore CPA’s and Consultants). Another less than desirable aspect of these types of plans is they will only cover tuition and certain fees. What does that mean? Typically, most school will charge additional fees such as parking, athletic facilities, capital improvement on top of the credit hour tuition fee. Lastly, these prepaid plans require a monthly contribution that is set at the time the plan is initiated. If you can no longer afford the predetermined payment plan, they will adjust your plan in accordance with what you can afford. This means you can pay less but you will receive less.
Also, should your son/daughter choose not to attend college, the plan will only refund want you contributed. It will not refund any projected growth. In simple terms, the prepaid plan will hold your money for x amount of years and only return your money. Let’s use an example to illustrate this:
Newborn parents start a 4 year college prepaid plan including room and board. According to myfloridaprepaid.com, the current rate for this plan is $176.97 (120 credit hours) plus $47.89 for room/board = grand total of $224.86. This is the monthly payment for 223 months (18.5 yrs). This equals to $50,143.78 that the parent contributed to the plan. If the child decided at 18 yrs of age college isn’t for him, Florida prepaid will refund the 50K. No problem. What if they do go to school. The plan estimates that you will have $66,500. Nice! However, using the inflation factor of 3.2% average for 18.5 yrs roughly equals 59.2% increase over the current tuition costs of $38,748 mentioned earlier. This would mean college tuition for the same school in 18.5 yrs will roughly cost $61,686. Great!!! you are covered. But what happens to the unused portion? ($66,500-$61,686=$4,813). Florida Prepaid keeps those funds unless you have another child to transfer the funds.
529 Plans
529’s offer a flexible tax-free savings plan. Unlike state-sponsored prepaid plans, 529’s belong to you. They provide the flexibility as to when, where and how the funds may be used. They are typically offered by the states as well, however they are not guaranteed like the prepaid plans because with 529’s, you are taking on the risk of the underlying investment vehicle. To the uneducated eye, that might seem very risky. Typically, there are three types of 529’s investment portfolios offered. They can either be age-based portfolios, risk tolerance based portfolios or customs portfolios. Let’s take a closer look at the pros and cons.
Pros: As already stated, these plan allow for the principal invested to grow tax-free as long as the funds are used for college expense related items. These items can include; Tuitions and Fees, Books, Housing and Food, Technology and special needs equipment. 529’s allow for a max yearly contribution of $14,000 for single parent and $28,000 for married parents. Broken down monthly, that would allow a max contribution of $1166/$2333 monthly respectfully. However, most 529’s will also allow as little as a $25/month contribution. Simply stated, there is a wide range of options. Additionally, even with conservative rates of return, historically speaking, 529’s have produce a larger total sum for the plan participant than those of prepaid plans. Let’s look at an example to better illustrate this point:
Using the same $224.86 used in the prepaid illustration, those funds invested monthly for 18.5 yrs and earning a conservative 3% rate of return would produce $67,317 / 4% = $74,659 and 5% = $83,027. Understand, the prepaid plan is investing your money and guaranteeing your contribution and estimating you will have roughly $66,500. That’s because they are making an additional $16,527 at 5% per client. Numbers are numbers.
What happens if the child decides not to go to college? Will you lose your money? No, you won’t lose your money. Possible alternatives include vocational schools, changing the beneficiary of the plan which could be a sibling, niece/nephew, grandchild or even a son/daughter-in-law, you can elect to become the beneficiary and go back to school, if the beneficiary receives a scholarship, you can withdraw the funds without penalty, you could leave it in the plan or you could simply withdraw the funds pay income tax on the funds plus a 10% penalty on the earnings.
Cons: The biggest concern when it comes to 529’s is the fact that these are investment type products and come with inherent risks. The market performance will determine to final overall value of the account. Understanding time horizons and risk tolerance are extremely important if you elect to go with a 529 plan.
Understanding what’s available is the first step in any decision making process. All content provided in this article is for informational purposes. For a personalized presentation, please contact me at louis@louisromero.com.