Saving for College- Prepaid or 529? (1 Viewer)

[Todd Hochard]

All,

I've got a two year old, as well as a little guy to arrive in December. My wife and I have recently been discussing options for saving for college.

One of the options is FL Prepaid. Basically, you pay the tuition at today's rates, and they are guaranteed full coverage upon entry. You can do one lump sum, 5-year plan, or pay monthly until they go to college. Of these options, I'd tend toward the lump sum (about $8000), even though I'd have to scrape some from an underperforming Roth IRA of mine.
Alternately, there are any number of 529 plans (such as the one from my TDWaterhouse broker) that we could contribute to. This increases flexibility, but given the cold, hard dose of reality delivered by the market in the past few years, it gives me pause. THEORETICALLY, rate of return could be higher (with better stock market returns) than the Prepaid (prepaid assumes a return of 6.5% or so, I think).
Additionally, I must consider the possibility of scholarships. My 2yo is exceptionally sharp (toot, toot! ), so should I slightly hedge my bets in this area??

Keep in mind, I am a man of modest means, the sole breadwinner on a modest (mid-five-figure) income. Paying for this will mean fewer toys (for everyone) and fewer vacations over the next few years. I do feel that it's important, though, to start soon. One of those "short-term sacrifice, long-term gain" kind of things.

Any thoughts on this from parents and/or financial planners out there?

Todd

 

[Brandon_T]

Keep in mind, I am a man of modest means, the sole breadwinner on a modest (mid-five-figure) income. Paying for this will mean fewer toys (for everyone) and fewer vacations over the next few years. I do feel that it's important, though, to start soon. One of those "short-term sacrifice, long-term gain" kind of things.

I am in the exact same boat as my first one is due in March. I am also trying to figure out what to do. Doing the prepaid is virtually impossible for me, but am interested as to what people have to say.

And no offense, but I have never heard anyone say that there 2,3 or 4 year old wasn't really smart. Don't bank on this. My wife is a school teacher, and says that every parent thinks there kid is the best in the class. Hey, same goes for me, no matter how much I think it, doesn't make it true.

Good luck and I look forward to seeing peoples responses.

Brandon

 

[JustinCleveland]

Kids are young, they won't miss the toys or the vacations...

Do it now, don't be in my boat (paying for a hundred thousand dollar education on my own).

Hopefully I can teach Public Speaking in Grad school... that would help defray my costs.

 

[Leila Dougan]

Additionally, I must consider the possibility of scholarships. My 2yo is exceptionally sharp (toot, toot! ), so should I slightly hedge my bets in this area??

No. I'm not going to say whether your child is exceptional or not because that's not the point. My brother and I have roughly "equal" intelligence, at least as far as standardized tests go. We got the same exact IQ score, and the same exact SAT and ACT scores (and pretty close to matching up in each subject as well). I graduated HS the top of my class and took several AP classes. I attended college with a full scholarship and did quite well. My brother, on the other hand, almost didn't graduate HS, barely sliding by with a 1.9 GPA. He did get admitted to a local college, but is starting out probationary (if it weren't for his test scores he wouldn't have gotten accepted at all).

So, intelligence rarely has anything to do with scholarships and the like. I know plenty of people that I went to college with that really weren't all that smart, but managed to get an even nicer scholarship than I did and got accepted to Ivy League medical and law schools. You can't really predict how things will turn out.

 

[Edwin_C]

It's good to plan out things early, but you don't need to this early. As the years go on your salary will increase. Take in all factors. Maybe you're one that likes to be better prepared for the future, but I don't see the point here.

2 things you need to understand.
1. The government will lend and give you money on a need basis when it comes to that time. This isn't something that's done by hard work, like scholarships, rather it's done for whoever needs it.
2. I'm not sure if doing this would obligate your child to go to a specific school, but give your child a choice. If you don't want to give them a choice, then go with the school you or your wife graduated from. Practically all 4-year institutions will give the child of an alumni 50% off for tuition.

Just save a little cash here and there and you should be fine. The only thing i'd worry about if I were you is the fact that if both your children go to college, then there will be 1 year where you have to pay 2 tuitions.

My 2yo is exceptionally sharp (toot, toot! ), so should I slightly hedge my bets in this area??

Don't take chances. Scholarships aren't based on intelligence solely, if at all. They're based on achievments.

 

[Todd Hochard]

Practically all 4-year institutions will give the child of an alumni 50% off for tuition.

This, I did not know. My wife went to UCF (I have no degree). I'll have to check with them.
My issue about hedging the bets was only that many of these plans are "pay a big fat penalty" or "get back your original investment only" 15-20 years later. It is the loss of saved money that concerns me. I'll handle the parenting aspect of achievement and motivation, thanks.

 

[Joe Szott]

Todd,

We just looked at all this and went for the 529 plan for both our children. There are a few benefits that make it MUCH more attractive:

* Your child can use it for any educational needs, not just tutition. Rent, Cars, etc. can all be covered under a 529 plan.

* It continues almost indefinitely. What if Jr. spends 4 years bumming around Europe, then suddenly wants to be a lawyer? The 529 is still there growing all the time.

* It is transferrable. Let's say your 2 yr old starts an internet business and doens't care to go to college. Then when child #2 goes to college and chews through his 529, you just transfer the older boy's 529 to the younger.

* If they don't use up all the money, the 529 plan just sits there growing indefintely. Heck, they can save it and pass it on to their kids if you want. 529s are trusts, they can switch owners and beneficiaries many times during its lifespan.

For the reasons listed above, basic flexibility. By prepaying you are locking your child into going to ONLY that one school at that specified time. What if your child can play the piano like Mozart and wants to go to Juliard? What do you tell him: sorry, but you have to go to Florida State? You never know what path they will choose, try to give them the flexibilties to do what they want to succeed.

529s can go down in value, but nothing is a sure thing. Florida State could go bankrupt in 10 yrs and then *poof* your money is gone for good. Unlikely, but who in the early 1980s thought that S&Ls were unstable investments?

529 is the way to go if you want to have the broadest coverage possible.

 

[Brian Perry]

I agree with Joe. Go with 529 and avoid the prepaid plans like the plague. Some states have already had to scale back or abandon the prepaid plans since they weren't able to get their investments to match the rising costs. The way I look at it, either the market will outperform the rise in tuition (in which case I'll wish I had been in the market/529), or the market will underperform the rise in tuition (in which case the system will collapse and you won't get the promised benefit).

 

[Holadem]

Let's say your 2 yr old starts an internet business and doens't care to go to college

Talk about sharp. Kids nowadays.

--
Holadem

 

[mark alan]

Don't count on the prepaid plans to work better than the savings plans. They only work if the invested funds do better than the increase in college tuition. If they do, then you would do better with a 529 plan, because that excess becomes yours. If they don't, then expect to be hit with a premium. She this quote regarding PA's program.

After meeting with TAP 529's financial advisor and actuary, Hafer said, she determined it would not be necessary to add premiums to the 2002-03 prices that go into effect Sept. 1. However, she said, "We are going to have to take a hard look at the numbers again next year. TAP cannot continue to absorb double-digit tuition increases if the financial markets don't recover. It may become necessary to impose premiums in the future to close the gap, actuarially, between assets and liabilities."

I personally don't expect the markets to outperform the ability of college to raise rates over the next 15-20 years. Nobody can beat colleges in ripping you off.

 

[Seth--L]

If the kid is that good, they'll want to go to Curtis, where tuition is actually free, and all piano students get their own Steinway while there.

 

[Leila Dougan]

Also, I'm not sure how your state works but in my state it works like this: You prepay tuition based on the current rates and you've guaranteed all costs are covered when the child enters college. But, if the child decides to go to some other school, you get your money back plus more. I'm not sure, though, if "more" is interest only, or the future tuition rate of the school. I'm pretty sure it's the latter, but I could be wrong. This eliminates the problem of Johnny wanting to go somewhere other than the local state university.

My parents set up a trust fund with lots of stocks and bonds that gradually matured over a period of several years. . starting when I turned 16 and the last one when I turned 23. I used the money for all my educational expenses that weren't covered by my scholarship (car, housing, books, etc). When the last one matured, I was well done with school and just pulled the money out. I could have also transfered it to my brother who's started college this fall, but he didn't need it (wasn't much money anyway).

 

[Todd Hochard]

Nobody can beat colleges in ripping you off.

I see you share the same disdain for some institutions of higher tuition learning that I do?

FL's prepaid, from my recollection, guarantees the costs. The prepaid works for any FL state school, and can be transferred to any number of schools, even out of state. Basically, I think the deal is that they'll pay prevailing FL state university rates to ANY college at the time of enrollment. I'd then have to come up with the difference. The list is extensive, to say the least- http://www.florida529plans.com/Prepa...col/index.html
I'm seriously doubting the FL state govt will go bankrupt. We'll just keep raising the tourist taxes to avoid that.

Normally, I'd invest. I've had the smack laid down on me on my other investments over the past several years. However, the guarantee is a small comfort that may be worth a couple of lost percentage points of investment money over the years, simply for the piece of mind (i.e. even if I lose my job, and end up at Home Depot for the next 15 years, it's taken care of).

This is what I'm trying to figure out. Decisions, decisions. There is talk of them discontinuing the Prepaid after this year, to assist in paying for the class-size amendment that was passed last year. Hence, my sudden sense of urgency.

Todd

 

[Seth--L]

They're the largest unchecked industry in the United States.

 

[DaveF]

Todd - I don't know anything about the FL Prepaid plan, but a rule of thumb I've come by is that "pay us now for a service you won't use for 18 years" plan is a bad for the purchaser.

If it locks your child into a specific school, or even into Florida, then it doesn't sound like a great long-term plan. You don't know where you child will be in 18 years. If he's "toot toot" smart maybe he will attend MIT, CalTech, or Rose-Hulman (my alma mater) rather than UCF. Or maybe your kid joins ROTC and gets college for free (some really smart friends did this.)

 

[mark alan]

look at it this way.

Suppose tuition is 8,000 and you expect to send a kid in 16 years. your two choices are put in 8K now for guaranteed tuition in 16 years or put in a certain amount each year.

Scenario 1 Investment growth equals tuition rate increase

Assume 8%/year. For the prepaid you're golden. For the yearly option, you would have to put in $850/year or a total of $5,600 more that the prepaid

Scenario 2. Investment growth doesn't equal tuition rate increase.

Assume 8%/year for investment, 11% for tuition. Under the prepaid, the state is short by $13,000 after 16 years. Multiply that by a large number of participants and you either have a bankrupt program, or massive surcharges.

Scenario 3. Investment growth exceeds tuition rate increase.

If you assume 8% tuition rate increase and 11% investment return, then you are giving $13,000 of your money to the state.

I personally think that Scenario 2 is most likely. If you believe that the state will foot the bill for underfunding, then the prepaid may be the way to go. I doubt it though.

 

[Todd Hochard]

If you believe that the state will foot the bill for underfunding, then the prepaid may be the way to go. I doubt it though.

In FL, the program has been around for 20+ years, and they've never shorted anyone, AFAIK.

 

[Brian Perry]

In FL, the program has been around for 20+ years, and they've never shorted anyone, AFAIK

However, the 20-year Bull market is over. How these programs cope with declining markets is the key.

 

[Kirk Gunn]

Are the tax benefits the same ? I believe the Pre-paid is a tax break on both the state and federal levels.

 

[Eric_L]

This is my professional arena, so of course I therefore am prohibited by the SEC to offer advice without a personal consultation face to face. (very true)

I will only say this:

I'm seriously doubting the FL state govt will go bankrupt

I've heard the same thing about California, NY, Enron, Kmart, Wards, certain municipalities, etc. It can and does happen. Florida seems to be taking a turn for fiscal conservatism, but that brushes on politics, so I end there.

My only advice is to see a financial specialist in your area. See more than one. Most consultations are free. Find a good one who has been in business for at least the last five years. (very educational time for advisors) Even with that you have only about a 50/50 chance of finding a good one. (I jokingly refer to myself as a 'Portfolio Repair Specialist' at the office.)

It is hard to interview advisors, and harder to give advice on picking one. The best thing I can say is listen to who does the most talking in the first meeting. If you do the most talking and they just ask questions and listen, that is a good sign. If they do most of the talking and ask for a signature afterwords, that isn't such a positive sign. Even at your income and asset level, you need and deserve full service advice. You may not be a big client now, but you will be someday. Make sure they are familiar with 529 AND prepaid.

If they offer you a solution, it will likely carry a load or commission. Provided the advice they give you is good (remember - 50/50) then it is well worth the cost.
Don't bet your retirement, your children's future and any other financial goals you have on an amateur (you). Use someone with *successful* experience doing this for hundreds of others.

I have plenty more to say. I guess it'll have to wait for my book. (someday)