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Are Prepaid College Plans Risky?

Aug 24, 2012

529 college savings plans come in two flavors. The first is an investment which typically consists of mutual funds. The growth is based on the market performance of its underlying investments. This growth is affected by market conditions and economic cycles so the the plans offer no guarantee of growing into an amount of money able to meet your college goals. On top of that you may even lose principle. The upside to this plan is you could see substantial growth if market conditions and your investment choices allow.

The other type of 529 account is a prepaid college tuition plan. Prepaid college plans allow you to purchase tuition credits at a rate that is fixed today to be used in the future. That “fixed” rate is usually higher than the current tuition rate, but would be much lower than the expected tuition by the time the child enters university. The benefit of this plan is your paying for your future college credits at today's lower rates.

The risks of prepaid college plans.

At one time 20 states offered prepaid college plans, today only 12 still do. The problem lies with state budget shortfalls and poor investment returns. When problems arise the first thing states do is close the plan to new investors. The rising costs of college tuition only adds to the problem.

Ohio closed their prepaid college plans to new enrollment in 2003 because of forecasted shortfalls because of declining investment returns and a rise in college tuition. Trying to make up the gap the state choose to invest in more riskier investments. The bet didn't pay off and they lost more money.

The second risk to prepaid college plans is they may not be guaranteed. Many consumers believe that because the plans are run by the states that the state will stand behind them. This is not necessarily true. Only five states truly guarantee their plans. Massachusetts, Florida, Mississippi and Washington guarantee their plans through the full faith and credit of the state. The Texas plan is also state-guaranteed, through the state universities and colleges.

Plans run by the states of Pennsylvania, Nevada, and Michigan are only backed by assets in the trust. Plans in Maryland, Virginia and Illinois require varying degrees of legislative action for the state to pay back investors in the event of a funding crisis, meaning that it may take consumer action if legislators are reluctant to bail out the state’s tuition plan fund.

There are no easy answers to this problem. But being aware of the risks will help you make better decisions. Seeking advice from a good financial advisor is always in your best interest.

Got further questions? Catch me on twitter and DM me @529SavingsPlans or e-mail me at 529CollegePlans at Gmail.comWant to be heard? Leave a reader comment below.

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