Apr 26 2010

Beware The Hidden Risk Of Prepaid 529 Plans.

Many people are familiar with the standard 529 plans as a means for saving for college tuition. They are much like a 401(k) plan in that the account holder can contribute money today and have it grow tax free – provided it is used for qualifying educational expenses. But there’s a less well known cousin to these kinds of plans.

Known as the Prepaid 529 plan, it allows the account holder to purchase tuition credits at today’s prices. Those credits are then exchanged for money to offset tuition costs when junior heads off to higher education. The parent buys a year’s worth of tuition credits today, in exchange for a year of tuition being paid for when junior goes to college.

The problem is that the states are supposed to invest that money so they can offset the future cost of tuition, only most states spend more money than they take in and many are teetering on the brink of bankruptcy.

For example:

Alabama’s Prepaid Affordable College Tuition plan, or PACT, has received most of the attention in headlines. According to BusinessWeek, administrators said that due to shortfalls, the plan can only pay tuition though fall 2011.

This kind of thing certainly makes me feel a little better about having chosen a traditional 529 plan for my kids college savings. I’d much rather handle the risk of the market, since I can choose what type of funds to invest the money in, rather than rely on politicians to be fiscally responsible with my child’s college savings.

Read the Morningstar article for the complete story and some ideas of what you may encounter if your plan is in a bankrupt state.


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