Friday, January 23, 2015

Private College 529 Plan May Be a Smart Choice

What if there were a guaranteed way to lock-in today's tuition rates at a diverse group of more than 275 private colleges across the country, for up to 30 years?

This could end up being a very significant benefit. According to data compiled by the College Board, the cost of attending a private, nonprofit, four-year college has been escalating rapidly. The 10-year percentage change in inflation-adjusted tuition and fees, from the 2003–2004 academic year to the 2013–2014 academic year, range from a low of 14 percent to a high of 48 percent, depending on the location of the college. The highest difference in cost was for colleges located in the Southwest. Schools located in the West had the lowest difference.

Assume today's tuition cost at the university of your choice is $35,000. If tuition rises at 5 percent a year, the cost of tuition at that school will be $57,011 in a decade. If you contributed $35,000 to a plan that guaranteed today’s tuition, your tax-free savings at the end of 10 years would be $22,011.

There is a way to protect yourself against these escalating costs. You can do so with a much underutilized and underpublicized plan called the Private College 529 Plan. It’s structured as a prepurchase of tuition and not as an investment. You won’t need to select investment options or be concerned about market volatility. The colleges and universities participating in the plan take the market risk and guarantee the plan’s obligations.

You can find a list of participating schools here. They include Stanford University, George Washington University, Emory University, Wesleyan University and Duke University. My alma mater, Johns Hopkins University, is also a participant. You can use accumulated prepaid tuition at any college that subsequently joins the plan.

The Private College 529 Plan has the same tax benefits as other 529 plans. As long as the money you contribute is used to pay tuition and mandatory fees at member schools, schools that don't have to be designated until the time of enrollment, there are no federal tax consequences. If you live in a state that offers a tax benefit for contributions made to any 529 plan, check with a tax professional to see if your contribution to the Private College 529 Plan can claim the same consideration.

Another significant benefit of the Private College 529 Plan is that 100 percent of your contributions go toward tuition. There are no entry fees, annual fees, service fees or exit fees. Although the Private College 529 Plan has many advantages, it does share the disadvantages attributable to all 529 plans. If you don't use the money contributed for tuition at a participating school, you'll be subject to a 10 percent penalty upon withdrawal. The penalty also applies if you contribute more funds than you end up using. You will be hit with the penalty when you redeem the excess funds.

This penalty can be particularly onerous if you need to withdraw the contributed funds due to an emergency, such as a health crisis. Contributing to any 529 plan decreases your liquidity. In addition, you are losing the opportunity to invest this money and possibly earn returns that may exceed the benefit you are gaining from participating in the plan.

Also, depending on where you live, your contribution to the plan may not qualify for any in-state tax benefits. Having assets in a 529 plan can affect the ability of your child to obtain other financial aid. However, for federal financial aid, 529 savings are considered parental assets, which are assessed in the formula for granting aid at a much lower rate. If your child applies for school-specific funding, the amount otherwise granted could be reduced if prepaid tuition credits are taken into consideration.

Although 529 plans permit changing the beneficiary without tax consequences if the new beneficiary is a "member of the family" as defined by the Internal Revenue Code, be sure any change you make qualifies. Otherwise, you could incur adverse tax consequences.

Finally, the Private College 529 Plan may limit the flexibility of the beneficiary to transfer from a college that is a participant in the plan to one that isn't. On balance, the Private College 529 Plan offers significant benefits for those who intend to attend a participating school. It should be seriously considered as part of your financial planning process.