529 plans remain better than pre-paid state school tuition plans

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There is a very good deal under the tax code for saving for college called a 529 plan. This is a tax-exempt account you can open and contribute to as you wish, where the money you put in grows tax free and gets spent tax free on college expenses. And the nice thing is the beneficiary can change from child to child as one child gets a scholarship, another decides to major in Harleys instead of Harvard or whatever else life can throw your way!

There are many of these 529 plans, even in a single state, but most of them are garbage. You see, states have to sponsor plans, but they’re run by financial houses. In many cases, the states sponsor outrageously high-cost plans that wipe out any real tax benefit and do nothing but harm your wallet and your child’s college education savings fund.

That’s why I work so hard coming up with a list of good 529 plans by state on clark.com.

I’m also asked about buying pre-paid tuition credits at state schools in states where this option is available. Well, those plans are under assault. Smart Money magazine reports 8 of the plans are now shut down, and others are teetering on insolvency. That’s because states planned them without good math behind them and the money that parents put in was not enough to cover tuition years later.

In some states, the state is the guarantor of the pre-paid tuition plan, but in others it’s not. So there are now lawsuits where parents feel cheated by their states. As far as money the not being there for your kid, don’t waste a lot of time worrying about that. If these plans do go insolvent, legislators typically come in and back the plan (at least for those already enrolled) even if there’s no explicit state guarantee.

But pre-paid tuition plans will be a less and less viable choice. Americans move so often around the country, and despite your best intentions, a kid may choose a different path other than a state school. That’s why my preference is and remains for a 529 plan rather than a state pre-paid tuition plan.

If you’re in a prepay plan, no need to change anything or head for the hills. But if you’re making a decision about which to do today, my preference is the 529 account.

Note: This segment origianlly aired February 2011



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