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There are two types of 529 plans available. Learn about their key differences so you can choose the right option for your child’s college fund.
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As a parent, you may want your kids to have the opportunity to continue their education after high school. Not only is it a rewarding experience for them, it’s one that can benefit them financially, as well. Average U.S. income data compiled by The Motley Fool Ascent found that workers with bachelor’s degrees earn nearly twice as much as high school graduates.
But going to college in the United States isn’t cheap. The average cost is $36,436 per year, according to the Education Data Initiative. Many parents open tax-advantaged 529 plans to save for their children’s future college expenses.
If you’re thinking about setting up a 529 plan, there are two different types of plans available. You’ll want to know how they differ and their pros and cons before you decide which one to use.
1. You can either invest through an education savings plan or pay for tuition in advance with a prepaid tuition plan
With 529 plans, you have the option of an education savings plan or a prepaid tuition plan. Here’s how they let you save for college costs:
An education savings plan lets you set up an investment account for your child’s future education expenses. You can use the money you deposit to invest in stocks and bonds. 529 plan providers normally offer age-based plans, where the plan provider sets up an investment portfolio based on when your child is expected to start college. Or, you can pick the investments yourself.A prepaid tuition plan lets you purchase units at participating colleges at their current prices. These are typically only available with public, in-state universities. By prepaying for tuition this way, you effectively lock in that rate and don’t need to worry about prices rising in the future.
So, with an education savings plan, the point is to grow college savings as much as possible by investing it. A prepaid tuition plan is a way of guaranteeing you get today’s tuition rates.
2. Most states offer education savings plans, but only eight offer prepaid tuition plans
Your 529 plan options depend on where you live, and education savings plans are much more widely available. Every state except Wyoming (which doesn’t offer any type of 529 plan) offers an education savings plan.
While there used to be 22 states with prepaid tuition plans, many have gotten rid of them. There are now only eight states that offer this type of plan:
FloridaMassachusettsMichiganMississippiNevadaPennsylvaniaTexasWashington
If you don’t live in one of those states, then your decision on which 529 plan to choose is pretty much made for you. And if you do, it’s also worth mentioning that many states only allow you to open a prepaid tuition plan during certain enrollment periods.
3. Education savings plans can pay for more types of college expenses
Students can use funds in education savings plans for any qualified education expenses. Qualified education expenses include:
Tuition and fees at college or trade schoolBooks and suppliesFood and meal plansRoom and board, including off-campus housing
These plans generally allow withdrawals for education costs directly to the beneficiary’s bank account, too. This makes it easy for students to use their college savings.
Prepaid tuition plans are far more limited. Since you’re purchasing college units, funds in a prepaid tuition plan generally can’t be used for any other types of expenses. That means students can’t use them to cover expenses for their books, food, or housing.
It’s also worth reiterating that units purchased through prepaid tuition plans are only valid at participating universities. If your child wants to go to another university, such as an out-of-state school, funds in a prepaid tuition may only cover a portion of tuition costs.
For most parents, education savings plans are the better way to save for college. They’re more flexible in how the beneficiary uses the money and available in almost the entire country. If you live in a state with a prepaid tuition plan, it may be worth considering if you want to lock in a tuition rate. But you’ll need to be confident that your child will go to a participating school.
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