The new Independent 529 Plan lets you pay future tuition bills at today's prices.
MANY PARENTS DREAM of sending their child to a tony private university. But with prices already staggeringly high -- the average private-school bill is $29,541 according 2003-04 figures released by the College Board -- it's a wish many parents simply can't afford. And it's only going to get more difficult: Should prices continue to climb at a 5% annual clip (not unreasonable, given historical averages), in 18 years four years of private higher education will come with a price tag of nearly $300,000.
But for people determined to take on this burden, a new college-savings option could help lighten the load. Through the Independent 529 Plan, parents (or grandparents, or whomever would like to contribute to an account) can pay today's tuition prices for future tuition bills at more than 220 private schools. In fact, participating schools will even provide an annual discount of at least 0.5% on today's tuition costs. So if the current tuition cost was, say, $20,000, the discount was 1% annually and you had 10 years until your child started college, you'd pay $18,088 today to cover one year of future tuition. And unlike other 529 plans, there are no fees for participation.
Previously, the only prepaid tuition plans available were for in-state beneficiaries attending public universities. Nineteen states offer these plans, although several aren't currently taking contributions because of market losses incurred over the past few years.
With its private-school focus and its nationwide scope, the Independent 529 plan is a new breed of the prepaid plan. "It's another good option for parents to consider -- especially if they're pulling their kids toward private college," says Joe Hurley, founder of Savingforcollege.com, an independent Web site that tracks the 529 industry. It's worth noting, however, that the plan covers tuition only -- which is just one slice of college costs. Other costs, such as room and board and book fees, aren't included.
Participanting schools include Syracuse, Princeton, Vanderbilt, Notre Dame, the University of Chicago and Spelman. (Click here for a complete list of participating schools.) Right now, Princeton is the only Ivy League school that's included, says Douglas Brown, president and chief executive of the Tuition Plan Consortium, the nonprofit group that will oversee the program. But he anticipates that more schools will continue to join the club. "(Schools) will find that they will attract more tuition-paying students," he says. "Financial-aid budgets are under a lot of pressure, and when people show up with actual cash, it's a welcome event."
Intrigued? Parents who are fully confident that their little bundle of joy will attend a participating private school should be. Families, for example, that come from a long legacy of Notre Dame grads have every reason to be enthused. But everyone else needs to understand the drawbacks -- and they are substantial -- of this plan before participating.
Private School or Bust
The biggest potential snag, of course, is that there are no guarantees that the account beneficiary will attend a participating school. There is, after all, that little problem of acceptance, and sadly, participating in this plan will not give applicants any sort of competitive edge. Then there's the issue of whether the beneficiary will choose to attend a participating school. (And, really, can anyone ever really predict the behavior of an 18-year-old?) Sure, with 223 schools participating, students have a wide selection to pick from -- but that still leaves out thousands of private and public schools. "It's very risky to be locked into those schools -- many of which are highly selective to begin with," says Kalman Chany, author of "Paying For College Without Going Broke." And students with specialized interests, such as, say, music or art, may find the list lacking, adds Chany.
The good news is that refunds are available. Should you decide to pull money from the account for something other than tuition costs at a participating school, you'll receive an annual return that ranges from 2% to -2% (depending on the market's performance for each year you participated). If the withdrawal will be used for higher-education expenses -- say, for tuition at a nonparticipating school -- it will be tax- and penalty-free. But nonqualified withdrawals will be taxed as ordinary income and hit with a 10% IRS penalty (as is the case with any 529 plan). Needless to say, had you invested the money on your own for several years, you most likely could have earned much better returns than 2% -- and you wouldn't be limited on school selection, notes Chany.
Another potential drawback to this plan is the negative effect it can have on financial aid. Using the federal methodology, which is used for financial aid granted by the federal government, withdrawals from prepaid plans are considered a student's resource, and thus cut the student's financial-aid "need" dollar for dollar. This is significantly less favorable than the treatment a 529 college-savings plan receives. (Under the federal methodology, a 529 college-savings plan is viewed as an asset of the contributor rather than the beneficiary, which generally means a financial-aid officer can count a maximum of only 5.7% of the account balance when assessing your child's financial-aid eligibility.)
The Tuition Plan Consortium is pushing for legislation to be introduced to change the law so that prepaid plans receive the same treatment as 529 college-savings plans, says Brown. But until that day comes (if ever), this is "real bad news" for many participants in prepaid plans, says certified college-planning specialist Rick Darvis of College Funding Inc.
Of course, the private schools themselves provide financial aid as well, although the way 529 plans are treated varies by school. To avoid harsh surprises, parents should contact the schools their child is considering and ask how 529 plans are assessed, says Savingforcollege.com's Hurley. (For more on this, click here.)
The other potential problem with all forms of 529 plans is that their tax-free treatment is scheduled to end in 2010. Many 529 experts believe that the favorable tax treatment will be extended, but plan participants should understand that at this point there are no guarantees.
So who should be considering the Independent 529 plan? Chany suggests that those with children who are just a few years shy of their college years may be the best candidates. For starters, by this age, parents should have a sense of the type of school their child may want to attend -- as well as their likelihood of acceptance. Also, with tuition bills looming, parents want to invest conservatively, which means that they probably won't be able to significantly beat tuition inflation (which has averaged 5.35% over the past 10 years for four-year private schools, according to the College Board) by investing on their own. The potential snag in this strategy is that the funds must be held for 36 months before use, which means that parents with children who are age 16 or 17 will most likely only be able to cover the tuition costs of junior and senior year.
Alternatively, once a child has decided which school he or she will attend, parents can ask the college itself if they can prepay their tuition bills on their own, says Chany. Many schools, including Dartmouth College, allow cash-rich parents to pay their bills upfront (outside of any prepaid plan), thus avoiding tuition hikes during their child's attendance.
Ultimately, choosing the best college-savings strategy comes down to the amount of flexibility you'd like. The Independent 529 Plan is a conservative bet with limited flexibility. Those looking for a little more control will be better off with a 529 college-savings plan, which at least allows participants to choose from a small group of investment options, can be adjusted on an annual basis and offers participants the opportunity to readjust their portfolios on an annual basis. With this type of 529 plan, there are no guaranteed investment returns -- but withdrawals can be used at any college and for any qualified college expense. (Many college-savings plans also offer some attractive state-tax benefits for in-state participants.) For more on why 529 college-savings plans are a wise choice for many families, see our story.