Rob Lieber wrote about prepaid 529 plans in his New York Times Your Money column: College Plans You Thought Were Safe. It calls to people’s attention that some prepaid 529 plans are not guaranteed by the states (some are). It questions whether these plans are safe.
I hate to be a contrarian again but I must say the prepaid 529 plans are still safe.
In a prepaid 529 plan, the participants give the program a sum of money; the money buys a unit of future tuition (and fees) payments. The program administrators invest that money against their future liability. The problems faced by the prepaid 529 plans are two-fold:
- the program didn’t earn as much from the investments as the administrators projected; and
- tuition and fees rose faster than projected
Therefore there exists a potential gap. If the program continues to experience difficulties on both sides: low earnings and high tuition inflation, the prepaid plans will have problems with having enough money to pay tuitions and fees as the administrators thought they would be able to.
All true, but it still doesn’t make a prepaid 529 plan unsafe, if by “safe” we mean the current participants will get their money back when their kids are ready to go to college. Matching or exceeding tuition inflation is a difficult task, but achieving a zero return is not that hard. I would venture to say the current investments in these prepaid 529 plans are safe.
I would even venture to say the current participants in the plan will see a positive return. Not fully matching tuition inflation and not safe are completely different concepts.
The New York Times article talked about some programs are guaranteed by the states and some are not. It highlighted the Illinois plan, which isn’t guaranteed by the state of Illinois. Even if it is guaranteed, the guarantee is only as good as who’s guaranteeing it. The state of Illinois is among the states with the lowest credit rating and the most severe budget problems.
You also have to consider the alternatives. If investment returns are low and tuition inflation remains high, a 529 savings plan in which you invest on your own is going to fall short as well. So you are not necessarily better off investing on your own versus buying into a prepaid 529 plan.
When it comes to meeting future college expenses, those prepaid 529 plans are as close to a guarantee as you can get. Not that the guarantee is bulletproof or that the guarantee is worth it at any price, but there is simply no guarantee anywhere else.
Read also: As Some Prepaid Tuition Plans Struggle, Is Your Money at Risk? by Matthew Amster-Burton at MintLife.