retirement

529 prepaid plans more compelling now

Last week's passage of the Deficit Reduction Act of 2005 is all but a done deal, merely waiting for a presidential signature. While the legislation contains provisions that hurt college financial aid (and other social) programs, it does contain a "silver 529 lining," says 529 plan expert Joseph Hurley.

"Money moved from an UGMA/UTMA account into a 529 plan will no longer be considered a student asset in the financial aid formula," Hurley told attendees last week at a 529 plan conference in Coconut Grove, Fla. Hurley, who founded the Web site savingforcollege.com, writes the " College Money Guru" column for Bankrate.com.

Instead, it will be considered a parental asset, a good thing because only about 6 percent of parental assets are counted in the federal formula that determines the expected family contribution toward college costs. Meanwhile, a much larger portion -- 35 percent -- of student assets count, though this is scheduled to decrease to 20 percent beginning with the 2007-2008 school year.

More interesting is that prepaid tuition plans, the forerunners of 529 college savings plans, will now be treated as parental assets in the computation of the financial-aid formula. That's great news for families who purchased a prepaid tuition plan.

Previously, these plans were penalized from a financial aid perspective because they resulted in a dollar-for-dollar reduction in the cost of attendance, reducing eligibility for financial aid. Their treatment as a parental asset becomes effective in July.

Prepaid plans not a red-haired stepchild

For whatever reason, prepaid tuition programs seem to get little attention among college savings vehicles, as if 529 savings plans were superior in every way. But in my view, locking into and paying tuition costs ahead of time offers a lot of advantages -- particularly in an environment where annual tuition inflation rises at more than twice the rate of regular inflation as measured by the consumer price index. You may not be paying today's tuition rates tomorrow, since future tuition costs are factored somewhat into the price of these prepaid plans, but you won't have to worry so much about spiraling costs.

Proponents of 529 savings plans say there's always a chance that investment returns will keep up with and possibly beat rising tuition costs, but that seems like poppycock to me. Yeah, there's always a chance that you might win the lottery, too.

That's not to say that you shouldn't invest in 529 savings plans. The prepaid tuition plans for the most part only cover tuition costs for in-state schools. That represents a substantial portion of college costs, but certainly not everything. Students need food, shelter, books, a computer, notebooks, supplies, etc., to stand a chance of getting good grades. So families that can afford to save money in advance of college costs should consider investing in both types of 529 plans.

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But for those families who don't have a lot of discretionary income, investing in a prepaid plan is much better than doing nothing at all. They offer some peace of mind that, at the very least, the tuition portion of college costs is taken care of. Now that the playing field between the two different 529 plans is pretty even from a financial-aid-eligibility standpoint, prepaid plans are more compelling than ever.

Characteristics of prepaid plans

In his book, "The Best Way to Save for College: A Complete Guide to 529 Plans," Hurley describes three types of prepaid programs. The most popular is the "contract" program where, as a resident of a state, you purchase in advance a certain amount of tuition credits that can be used at any public college or university within the state. You can make a lump-sum payment or a series of payments over a period of time, typically five years.

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