Texas Prepaid Tuition Vs. College Savings Plans
Rising Cost of College
The cost of college in Texas has historically outpaced the inflation rate. According to the Texas Higher Education Coordinating Board, the 2019-2020 average costs (including tuition and fees, books and supplies, room and board, transportation, and miscellaneous) for the University of Texas at Austin were almost $28,000, while Texas A&M was nearly $29,000. While other public institutions in Texas were priced just slightly lower at $26,000 for the University of Texas at San Antonio and the University of Houston at $27,000. The University of Texas System increases tuition by 2.6% for all campuses for 2020 and 2021, keeping pace with inflation.1
The Texas Tuition Promise Fund (prepaid tuition plan)2
The prepaid tuition plan had almost 50,000 individuals enrolled in it as of December 31, 2019, with nearly a billion in Assets Under Management. The prepaid tuition plans act as a contract in that you pay for units that will pay for future tuition. Only nine states have prepaid tuition plans that are currently open to new enrollees.
Some of the notable requirements are the beneficiary must be a Texas resident, it pays for only undergraduate education, and it has a three-year holding period before you can redeem units. But tuition units are paid for in current costs, so you lock in today's costs of college, which can be a real benefit. Texas public institutions must accept the tuition units as payments for tuition in full. It does not cover room and board, books and supplies, transportation, and so forth -only tuition and fees.
If the beneficiary attends an accredited out-of-state college or university, Texas private college or university, or career school, or the purchaser does a rollover to another 529 plan, the transfer value is paid. The transfer value is the lesser of 1) the costs the unit would cover at a Texas public college or university; or 2) the price paid for the unit redeemed, plus or minus the plan's net investment earnings or losses on that amount.
There are different payment methods, but the best, in my opinion, is the installment plan, where you can sign a 10-year contract and lock in college at today's prices.
Texas College Savings Plan3
The Texas College Savings Plan is where you make contributions to the 529 plan, and you can use it at most accredited colleges in the U.S. Compared to the prepaid tuition plan, it pays more of the full costs of college, including tuition, fees, books, supplies, computer equipment, and room and board. A 529 college savings plan, which all 50 states and the District of Columbia offer, is more flexible than a prepaid tuition plan and can be used for a wider range of expenses.
With the college savings plan, you are in charge of making the investment choices in low-cost mutual funds such as Vanguard and T. Rowe Price (around 0.60% expenses). In addition, you can select age-based portfolios and static portfolios depending on your level of risk.
With both plans, if your child decides not to attend college, you can change the beneficiary or withdrawal the money, and the earnings will get a 10% penalty, and you will pay ordinary income taxes.
What's the Best Choice?
The benefits of the prepaid college tuition plan are that you can lock in the cost of college at today's prices. You don't have to take any investment risk. The units will be honored by the public institutions in Texas. The drawback of the prepaid tuition plan is that you are limited to what it can pay for, only tuition and fees for undergraduate education. You are also limited to only choosing public institutions in Texas. If your child decides to go out of state or to a private college, you can get the transfer value, but the best value is if you use it for its intended purpose. You will also need to come up with additional money to cover the other costs of college, such as room and board, books, supplies, and so forth.
The college savings plan has benefits in that you can select any accredited academic institution across the U.S. You can use the money for both undergraduate and graduate education, and it covers the full costs of college. The drawbacks of the college savings plan are that you are in charge of the investments and bear the risk if your investment choices don't work out.
The prepaid tuition plan is a smart choice, and I believe often overlooked since you are getting value from not having to worry about the future cost of college, which is a real benefit. You also don't have to assume the risk of your investment choices. For a conservative investor, this can be an intelligent choice. For those who want to assume more risk but want colleges' flexibility, the college savings plan is an intelligent choice.
Prepaid tuition 529s plans attempt to hedge some of those risks. You pay for future college credits today, so you don't have to worry that the market takes a nosedive between now and when your child starts school. You have the assurance that your outlay will at least keep up with college tuition inflation, regardless of how much college costs skyrocket. So essentially, you eliminate market risk and inflation risk.4
Savings for college is an important choice. However, it is best to get help from a financial planner to learn what option best suits your individual circumstances. Reach out to me on the contact page below if you would like to schedule an initial consultation.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.