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Updated on Thursday, December 10, 2020
Saving for college can feel daunting. Not only are projected tuition rates jaw-dropping — with some projections suggesting that private tuition will cost nearly half a million dollars in 18 years — but it’s also hard to sift through information about the optimal savings plan that’s right for your family’s needs.
If you have children it’s likely you’ve heard about 529 plans, but may be confused about the difference between Private College 529 plans and state-run 529 plans.
In this article, we’re going to explore how these two plans differ. But first, let’s quickly review what a 529 plan is.
Understanding 529 college savings plans?
A college savings 529 plan — also called an education savings plan — is a type of investment portfolio specifically earmarked for tuition expenses. When used for education expenses, the earnings from a 529 plan are not subject to federal tax and, in most cases, are not subject to state tax. Besides tuition, the money in a 529 account can be used for expenses such as miscellaneous administrative fees, books and room and board. Contributions to 529 plans are made with post-tax dollars.
A 529 plan can be set up at any time, even before you have children. It’s possible to set up a 529 plan and then name your child as a beneficiary once your child is born. These plans are a popular way to encourage relatives and friends to gift funds to your child’s education. It’s important to note that any contribution over $14,000 made by a single individual (which includes you as a parent) is potentially subject to a gift tax.
Nearly every state sponsors at least one 529 plan and you’re not required to be a resident of that state to choose a plan.
What is a prepaid 529 plan?
Like the name says, a prepaid 529 plan allows for a contributor to use pre-tax dollars to prepay college tuition at today’s prices. These may have limitations by state, residency and type of institution (for example, K-12 tuition is often exempt).
Prepaid 529 plans may cover the cost of tuition for in-state institutions, but they may only cover the “weighted average tuition” or minimum benefit for private colleges and out-of-state colleges, which may leave you on the hook for thousands of dollars to make up the difference. Prepaid 529 plans may also only pay for a certain number of credits.
What is a private 529 plan?
529 funds historically could be used for other types of tuition, while prepaid savings plans were meant for families who were planning for their child or children to attend a state school. Now, there’s the option to enroll in a Private College 529 plan.
Like other prepaid 529 plans, a Private College 529 plan allows you to lock in today’s tuition rates. Created by a consortium of nearly 300 private colleges and universities — including Middlebury College in Vermont, Smith College in Massachusetts and Stanford University in California — the Private College 529 plan sells “tuition certificates.” These certificates are then redeemed at participating schools when a student is ready to attend college. The amount you buy in tuition certificates locks in the cost of tuition at the time you purchased the certificate.
Let’s say you purchase $20,000 in tuition certificates in 2018. In 18 years, your child chooses to go to Middlebury College. Tuition for the 2018-19 school year at Middlebury is about $54,000, so your $20,000 tuition certificate covers roughly 37% of one year’s tuition in today’s dollars. When your child begins college in 2036, your tuition certificates will still cover 37% of a year’s tuition to Middlebury, regardless of how much tuition costs at that time.
Tuition certificates only cover undergrad tuition and mandatory fees (it’s uncommon to cover room and board) and only work at private institutions that are part of the Private College 529 plan. However, the money can be rolled over into a state-sponsored 529 plan or can be refunded. Refunds that are not used for higher education expenses are subject to a tax penalty.
Private College 529 plans and state-run 529 programs: What’s the difference?
For some, the Private College 529 plan may seem too restrictive. Alternatively, the idea of locking in current tuition rates and not having to worry about inflation can seem attractive. If parents and relatives have the means to gift the maximum allowable tax-free gift to a 529 plan on a yearly basis, choosing a Private College 529 plan could add up to a significant percentage of the total tuition in just a few years.
It’s possible to open multiple 529 plans for the same child, and some people find it makes sense to have both a Private College 529 plan as well as a state-run 529 plan. Not only can state-run plans pay for room, board and education expenses such as books and necessary electronics, but some also offer rewards programs and make it easy to roll over a state-run 529 plan to another family member.
|Features||Private College 529 plan||State-run 529 programs|
|Tuition rates||Locked in at the tuition rate the day the tuition certificate was purchased.||Tuition fluctuates and is subject to inflation. The money invested in a state-run 529 program will be used toward the cost of tuition for whichever year the beneficiary begins college.|
|Fees||No fees — all fees are paid by member institutions.||Most, but not all, state-run plans have fees, which could vary from $10 up to nearly $100 a year.|
|Investment risk||Tuition certificates are guaranteed to pay the percentage of tuition purchased, regardless of inflation.||A 529 plan is an investment product and is subject to market volatility.|
|Contribution limit||Contribution limit is based on the cost of the most expensive five-year tuition of a member institution. For 2020-21, it’s $305,500.||Contribution limit varies by state and plan, but contribution caps tend to range between $250,000 and $500,000.|
|Use of assets||Tuition certificates can be used for tuition and “mandatory fees.” Tuition certificates likely can’t be used for room, board and expenses.||Money from a state 529 plan can be used for tuition, fees, room, board and other expenses (including laptops), as well as education expenses for grad school.|
Tax considerations for a Private College 529 plan
Like state-run 529 plans, Private College 529 plans use post-tax money as contributions, which are not tax deductible. Private College 529 contributions may be subject to gift tax considerations if individuals gift over $15,000 to one individual. However, it may be possible to gift a $75,000 in one lump sum, prorated for five years, to one account. This could be an option relatives might consider for estate planning purposes, as the $75,000 in tuition certificates locks in the current year’s tuition rate.
If a student decides not to enroll at a participating college, the money in a Private College 529 plan can be rolled over into a state-run 529 plan. The potential disadvantage to that option is that the money in the fund will be rolled over depending on the money’s performance in the trust, at a maximum increase or loss of 2% each year. This means that you may have missed out on the maximum potential for growth. Additionally, any earnings could be subject to a tax penalty if you choose to get a refund.
Private College 529 plans and financial aid eligibility
If your child has a Private College 529, how will that affect financial aid? Private College 529s are considered a parental asset, which is assessed at a different weight than a child assets.
A parent must report all the 529 plans they own, even if they’re for younger siblings. You may not be required to report the 529 at all on the FAFSA if a grandparent is the custodian of the 529 or if the 529 is owned by a noncustodial parent.
Bottom line: Is a Private College 529 plan worth it?
A Private College 529 plan may make sense if you have a strong sense your child will attend an institution currently on the plan. If, for example, you and your partner are both alumnae of the same school, you may feel strongly that your child will attend it, too, and feel confident that a Private College 529 Savings plan is the best option for your family.
There’s always the possibility for new institutions to join the program and there’s no need to “pick” a school until your child enrolls in a college. It’s important to remember that enrollment in a Private College 529 plan doesn’t guarantee admission to a school, and the list could prove limiting to certain students.
Some parents like the flexibility of opening a Private College 529 plan as well as a state-run plan to cover all their bases. A financial advisor or planner can also help you decide if this saving strategy is right for you. One thing’s for certain: Whichever option or combination of options you choose, making a savings decision early can provide peace of mind for the future.