Prepaid 529 College Plans and Risks

Cliché: You get what you pay for.    
POCS Reality: Investments to help pay for college can be risky and impact financial aid eligibility. 

 

Investments can be risky- ask anyone on Wall Street or Main Street, but how much of a risk are prepaid 529 college savings plans?

The IRS describes a 529 plan, its 2 types, and advantages:

  • A plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild.
  • There are two basic types: prepaid tuition plans and savings plans. And each state has its own plan. Each is somewhat unique. States are permitted to offer both types. A qualified education institution can only offer a prepaid tuition type 529 plan.
  • Earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. Contributions to a 529 plan, however, are not deductible.

For 529 plans in general, investment performance is down but how does this amplify the risk?

According to Larry M. Elkin, CPA, CFP®, President of Palisades Hudson Financial Group LLC and Palisades Hudson Asset Management, L.P:

Prepaid 529 plans across the country have promised more in tuition benefits than they have the funds to deliver. In some cases, taxpayers are obliged to take up the slack, while in others the colleges themselves may be required to offer discounts to make good on the promised benefits. In still other cases, however, parents and grandparents who thought they bought the right for their offspring to attend college at a prepaid rate are likely to find themselves stuck with a broken pledge and a tuition bill, with no better recourse than to ask state legislators to bail them out.

Here are 2 questions about 2 risks:

  1. Isn’t “bail” as in bailout now considered another 4-letter word? Only a few states pledged to make up the difference if the investment does not keep up with rising college tuition costs.
  2. What if your student doesn’t want to attend a participating college – one that accepts the prepaid credits? A refund is available but, depending on the plan, may be limited to the original contribution, not any gains.

POCSmom’s College Prep DIY Insight: 529 plans are included as an asset on the FAFSA (Free Application for Federal Student Aid) in determining federal financial aid eligibility:

Investments also include qualified educational benefits or education savings accounts (e.g., Coverdell savings accounts, 529 college savings plans and the refund value of 529 prepaid tuition plans). For a student who does not report parental information, the accounts owned by the student (and/or the student’s spouse) are reported as student investments in question 41. For a student who must report parental information, the accounts are reported as parental investments in question 89, including all accounts owned by the student and all accounts owned by the parents for any member of the household.

 Parents should carefully research options before investing to save for college. Prepaid College 529 plans impact college financial aid eligibility, tax advantages, and risks.