Late-Stage College Savings Strategies

One of the bigger frustrations about 529 plans that I hear from parents is their reliance on investments to fund college. In the early accumulation years, parents don’t like the seemingly large allocations to fixed income that many plans have. As college nears, parents’ fears tend to group around two risk factors: market risk, whereby you might lose some or all of your savings in a poorly-timed market downturn; and inflation risk, where a conservative investment allocation means your savings are losing purchasing power due to inflation.

For some families, Private College 529 Plan may have an answer. A prepaid tuition plan, the Private College 529 lets families buy tuition credits now and redeem them at their inflation-adjusted value at a member institution in the future. As a refresher, a prepaid tuition 529 plan is essentially an inflation-protected college savings account. Let’s say, for example, that this year’s tuition is $20,000 and you deposit $5,000 in the plan. You’ve bought 25% of one year’s tuition. Fast forward three years and tuition, having risen by the 5% annual average, is now $23,153. And your prepaid tuition certificates still pay 25% of that year’s tuition, meaning you saved $788. Many states used to offer prepaid tuition plans alongside college savings plans; following skyrocketing public school tuition rates in the financial crisis a decade ago, many closed and now only about 10 states offer their own version of a prepaid plan.

Prepaid tuition plans have some drawbacks: funds only being eligible for tuition and fees (not room and board or books), and lockup periods or beneficiary age limits for contributions are among the bigger ones. In addition, students who enroll at schools other than the participating ones might find the inflation credits less valuable.

I bumped into some people from Private College 529 Plan at a conference I attended a few weeks ago and was intrigued, since my daughter will be attending one of their member schools. If you have a private college-bound student, you might also find it interesting. Here’s how it works:

You can enroll at any age from birth up, but you must leave funds in the plan for 36 months. That means a contribution I make now will not be useable until her senior year. Tuition is purchased at current rates and redeemed at future rates. As long as you attend a member school, today’s savings dollar retains its full purchasing power. And as with any 529 plan, growth and distributions are tax-free as long as they’re used for qualified expenses.

Private College 529 President Bob Cole puts it this way: “We see a value in offering a benefit to families who might not be eligible for much financial aid.” And it sounds like the member schools see it that way too: since the plan’s inception in 2003, it has grown to nearly 300 member schools, with only one school having left the plan. The schools themselves assume the investment risk—which may be fairly small given that college endowment funds returned an average of 8.2% last year, quite a bit above tuition inflation rates.

For families of students interested in lots of types of colleges who are a few years out from a decision, the plan has some risk: If you don’t attend a member school, your contributions grow based on the plan’s investment returns with those dollars, with a cap of 2% annual increase or decrease. That means that if tuition inflation skyrockets, your gain is capped at 2% and would lose purchasing power. According to Cole, 70% of plan redemptions went to member schools, with the remaining 30% either rolled over to other plans or refunded. State-sponsored prepaid plans generally credit the same inflation rate to students regardless of where they attend, but you’ll want to check the fine print on specific plans if you intend to go that route.

Here’s an added benefit for the class of 2019: Private College 529 runs on the same calendar as the FAFSA and other financial aid. That means that (as long as you’re reading this before June 30, 2019) tuition credits are still priced based on the 2018-2019 school year. So students who have committed to a member school can lock in senior year tuition at pre-freshman year prices. At our school, tuition and fees will go up just over 4% for the 2019-2020 year, far more than the typical 3% one-year return last year in an age-based portfolio for her age or the 2% return in a guaranteed fixed income option.

I see a lot of benefits to this plan for my situation: I lock in four years of inflation-adjusted returns in just three years with no market risk, I retain the tax benefits of a 529, and I have some dedicated money available for my daughter’s senior year. My daughter’s college’s tuition has gone up by at least 4% every year since 2001; if that continues to be the case, we come out ahead even net of our state tax deduction (which I can take for contributions to my son’s account anyway). I was fortunate to have some funds available for a contribution, so I didn’t have to worry about state tax deduction recapture if I rolled money over from our existing plan. And I have other money in my state’s 529 that can be used for the first three years and for room and board. Your situation may be different, so you should also be apprised of the risks:

• Prepaid tuition plans can only be used for tuition and fees, not room and board. Remember that if you have a partial scholarship, it probably goes against tuition. So you might not have enough eligible spending for this to make sense. And if you take a nonqualified distribution of the excess, you get the up-to-2% rate, not your school’s rate. (If your nonqualified distribution is due to a scholarship, you don’t pay the 10% penalty.)
• Private College 529—like most prepaid programs—is for undergraduate tuition and fees only. Students in direct-admit graduate programs such as 5 year MBA or 6 year physical therapy programs should be careful to understand when the school deems their undergraduate years to end, as it’s often sooner than four years.
• The program requires prepaid tuition certificates to be held for at least 36 months before redeeming, so if you are considering this now for a student in the class of 2019, you are considering it for senior year of college.
• If your student transfers to a non-member school, you get only the “up to 2%” program return so you could lose purchasing power.
• Families considering rolling funds over from their state 529 plan should be familiar with the state plan’s tax deduction recapture provisions. (In plain English, that means that if you took a tax deduction on your contribution and are now rolling it to an out-of-state plan, you might have to repay the tax deduction.)

Cole sees the Private College 529 as one arrow in a family’s quiver. He points out that many families use it in conjunction with a 529 savings account, in part because those can cover a broader range of expenses. In fact, Sallie Mae’s 2018 How America Saves for College study showed that the average family who is saving for college began saving when their oldest child was 7; in comparison, Cole says the median age of his plan’s beneficiaries is 12-13, an age at which some parents might have a better sense of which direction their child is headed.

And of course, Cole had some sage advice for parents of college-bound children, no matter their age or likely college: “Save early and save regularly.”