Prepaid college savings plans have long been an alternative to a 529 plans when it comes to saving for college.
What is a prepaid college tuition plan? Generally speaking, these plans let parents lock in college tuition at today’s prices with the goal of funding school ahead of time. The idea behind these plans is letting families purchase college units or credits with a lump sump payment, or through regular payments, at which point the plan administrator invests the money on their behalf.
With the money stashed away and invested, the goal of these accounts is growing the underlying funds to keep up with rising tuition costs until the child reaches college age. At that point, the funds are transferred to the school to cover tuition costs and other eligible higher education expenses.
While that all sounds good and well, something is going wrong in the prepaid college tuition industry — at least in the state of Maryland. In fact, WMAR 2 News in Baltimore recently reported that Maryland prepaid tuition plans have some sort of accounting error that is locking account holders out from their earned interest right now.
Parents who paid into the Maryland 529 Prepaid College Trust plan are saying they do not have access to all of the funds in their accounts that they need to pay college tuition bills. Maryland 529 also informed account holders back in August 2022 that interest was being withheld due to an internal math error.
Funny enough, the error itself dates back all the way to November 2021 when Maryland 529 switched systems. But, now it’s well over a year later, and it appears that families aren’t getting any answers.
Student loan expert Mark Kantrowitz, who is also a Forbes Contributor, says that “something strange” is going on in Maryland since it doesn’t take a year to fix an accounting error.
“The parents may need to file a lawsuit to get answers,” he said.
While they wait, some parents created a Facebook group to vent about this issue and discuss potential solutions. “Free Our Interest NOW, Maryland529!!!” currently has 805 members, and it’s showing several new posts per day.
Pros And Cons Of Prepaid College Tuition Plans
While you ponder the issues plaguing college savers in Maryland, it’s probably smart to consider all the pros and cons and prepaid college tuition plans before you start using one. After all, some of the plans offered in different states are much better and a lot more flexible than others, and there are some general risks to be aware of as well.
First off, you should know that prepaid college tuition plans appear to be fading and becoming less popular overall. In fact, 22 different states offered such a plan several years ago, whereas only nine states offer one now.
If you do have access to a prepaid college tuition plan, Wilmington Trust’s Family Legacy Advisor Jerry Inglet says you should know that these plans are only usable for college tuition and fees, and not on ancillary expenses like room and board (like you could with a traditional 529 plan).
“This is not necessarily a risk, but a consideration that students and families can keep in mind as they plan financially for the full cost of college attendance,” said Inglet.
College planning advisor Paul E. Compeau of BridgeWise College Planning points out that, in some cases, schools will just raise the cost of room and board to try to recoup some of these costs.
“It seems this is happening at many Florida schools right now,” he said.
Another potential downside of prepaid tuition plans includes scenarios where colleges make the decision to charge more than current in-state tuition upfront. Compeau says that Michigan prepaid plans charge more than $23,000 for some students to purchase two semesters of school, whereas in-state tuition falls between $11,000 to $16,000 per year.
“It’s not really prepaid if it’s a higher cost than current rates,” he says.
Dr. Robert Kohen of Kohen Educational Services also adds that parents rarely foot the bill for prepaid tuition upfront, and that they usually get on some kind of payment plan or borrow money from the college. With that in mind, he says parents need to carefully consider the terms of any loans and whether the cost of borrowing exceeds the anticipated cost of tuition increases.
Kohen also says college tuition increases can vary by year, but that a 5% average annual increase can be a useful ballpark estimate.
“If a family has the funds to prepay without borrowing, they should ask whether their anticipated return from investing the money would exceed the anticipated savings,” he says.
In the meantime, parents need to read the fine print for any prepayment plan. For example, they should find out what comes next if their student quits attending college after they set up and funded a prepaid plan.
Will A 529 College Savings Plan Leave You Better Off?
While the situation may be different for everyone, there are some compelling reasons to consider a 529 college savings plan over a prepaid tuition plan. The first one is the fact that 529 savings plans can be used to attend any accredited institution of higher education, whereas prepaid college tuition plans are often only usable for in-state tuition at one of the state’s in-state colleges or universities.
Some states also offer tax advantages for residents who contribute to a 529 plan in any given year. In the state of Indiana, for example, college savers get a 20% tax credit on the first $7,500 contributed, which translates to up to $1,500 from the state at tax time.
Financial advisor Danny Cieniewicz of Hyperion Financial also points out that 529 college savings plans tend to offer underlying investment options that can help families secure market returns. Further, 529 plans have become incredibly flexible in recent years due to legislation from the Tax Cuts & Jobs Act, and SECURE Act and SECURE Act 2.0.
For example, Danny Cieniewicz says you can use 529 funds to pay for private tuition (up to $10k/year) for K-12 expenses or pay off up to $10,000 in student loan debt over your lifetime. Beginning next year, savers with a 529 plan can also roll over up to $35,000 in unused 529 plans to a Roth IRA up to annual limits.
“There are stipulations to each feature, but Congress has added massive flexibility to these plans that have made them a great tool to plan for,” said Cieniewicz.