The Raw Essentials of 529 Qualified Tuition Plans

529 Qualified Tuition Plans

One of the most popular numbers in the college planning world is Five Two Nine (or 529). That is because section 529 of the internal revenue code vastly expanded the number of tax-advantaged plan options available to parents to help save for the increasing costs of college education.

In addition to numerous tax law changes under 529, Qualified Tuition Plans (or QTP's for short), were granted tax-exempt status if they were created, sponsored, and maintained by the 50 individual states.

The term "529 plans" is basically synonomous with the term "QTP's." The plans that I will discuss in the coming paragraphs then are sub-types of 529 plans and each possesses their own unique advantages and disadvantages.

The purpose of this post is to establish the precise plan definitions, rules, and regulations. In later posts, I will relate specific plan types to specific possible instances where the use of the plan would be advantageous.

But for now, lets just focus on the Raw Essentials! ...

529 Prepaid Tuition Plans

Do you think it would be advantageous to have a child today and pay today's rates when that kid goes to school in 18 years?

Well, more or less, that is the general idea behind a prepaid tuition plan. You get to buy "tuition credits" in today's dollars that can be redeemed for enrollment at some point in the future. In this way you essentially lock in the cost of college.

2 points of caution

While it may seem you are getting a deal there are two important considerations before you start tying up money in a pre-paid tuition plan.

  1. You are assuming the child will attend the school you are buying credits for. What if the child does not qualify academically? How about if they don't want to attend school at all? Or that school specifically? What if he/she receives a scholarship?
  2. The pre-paid tuition credit is only good at the school for which you are purchasing the voucher
  3. (Check the specific reimbursement policy from the school to mitigate the risks above).
  4. Carefully monitor tuition and tuition related expense increases. Althought most planners are projecting tuition expense increases in the neighborhoo of 4-6% annually, this may not in fact be reality. The reality might be that tuition costs could be less than those projections or even flat for several years, based on various external economic conditions. Work with your planner on an annual basis to continually make adjustments to your strategy.
  5. By investing your money in pre-paid tuition, you may be foregoing the opportunity to earn a higher rate of return, which could outpace the cost increases at the schools your child is likely to consider.
  6. (Work with a financial planner and monitor your tuition purchase plan)

529 Traditional Savings Plans

Savings Plans are the most common utilized form of the Section 529 QTP. The savings plan allows your contributions (which must be in the form of cash) to grow tax deferred and when withdrawn are received income tax free -- if you use them for qualified education expenses of course.

I mentioned in the last heading that pre-paid tuition plans essentially lock in the cost of college in today's dollars. This also locks in your earning ability on this money. In a 529 savings plan, you will be able to participate in higher possible returns by keeping the money liquid and free of the lock in that is binding in a pre-paid tuition plan.

Another key advantage of the savings plan is the ability to flexibly choose which university the funds may be used at and the ability to reclaim the funds, should the child not actually go to school. It is for these reasons that the 529 savings plan is usually the preferred choice.

Summary

In summary, there are two types of 529 plans or QTP's. - the Prepaid Tuition Plan or the Traditional Savings plan. You can think of them this way... Prepaid plans allow you to lock in costs in today's dollars. They are more rigid and usually must be used at the institution where the credit was purchased. On the other hand, traditional savings plans offer more flexibility and may earn a high rate of return, but the downside for these plans is that there is a strong element of investment risk involved.

Keep an eye out for more posts as I go into plan mechanics and specifics.

Eddie Patel