Questions about State Prepaid 529 Plans- READ THE FINE PRINT “there is no true guarantee"

[Anonymous]

Our DD is 2.5 yo and started thinking about the Virginia's Prepaid 529 Plan. We are having second thoughts after reading the NYT piece. It states that, in Virginia (and Maryland) do NOT guarantee that the state will cover the tuition inflation if its own investment have underperformed. Read the fine print and choose carefully.

http://www.nytimes.com/2011/04/02/your-money/paying-for-college/02money.html?pagewanted=1&_r=1

[Anonymous]

That's true, but for MD I think it's guaranteed that any shortfall will be included in the Governor's budget and the legislature would have to affirmatively cut it for the funds not to be available.

It's a risk, but so is relying on market returns to match or exceed the rate of tuition growth (which is one reason why we have money in both plans in MD).

[Anonymous]

Yeah I read that too. We decided to go with a regular 529 because we didn't want the penalty if our kids go out of state anyway. I don't trust anything, but it's a great way to save for your childrens' future tax free.

[Anonymous]

There actually isn't a penalty in MD if your kid ends up out of state.

[Anonymous]

Isn't a prepaid plan different from a 529? I thought a 529 was basically a mutual fund with tax advantages if the profits are used for college expenses.

[Anonymous]

Anonymous wrote:Isn't a prepaid plan different from a 529? I thought a 529 was basically a mutual fund with tax advantages if the profits are used for college expenses.

there are two kinds of 529-- a prepaid plan and a savings plan. Both are tax-sheltered savings plans for college. Because the savings plan (which is usually invested in mutual fund(s)) is more common/popular people usually use "529" to refer to that kind.

[Anonymous]

My understanding is that many prepaid plans assume a low interest rate on your investments, which shifts the risk away from the state (if they assume your investments will earn 2-3%, this means you make higher monthly payments, and have a more of a chance of reaching the goal of full tuition paid by entrance). But it means that you are getting a worse return on your investment than if you invested in the state's regular college savings plan. Plan specifics vary from state to state, of course.

[Anonymous]

I assume the PP refers to the "penalty" of Maryland only paying the equivalent of in-state tuition toward whichever school you choose, not actually matching the real tuition cost.

[Anonymous]

Anonymous wrote:I assume the PP refers to the "penalty" of Maryland only paying the equivalent of in-state tuition toward whichever school you choose, not actually matching the real tuition cost.

If you're referring to me, 16:44, that's not quite what I meant. When a prepaid plan figures out your monthly benefit, they have to project what they think the tuition will be in 17 years when your kid enters. Then they back out a monthly payment for you, building in an assumption about what rate of return your monthly payments will earn as they compound over 17 years. It's a bit like how the mortgage company calculates your monthly mortgage payment (although not exactly). In any case, if the prepaid plan assumes you will only earn 2-3% annually on your payments, this means you will have to make higher monthly payments to reach the goal of full tuition at age 17.