529 college savings plan

Prepaid plans can be very complex. The only one I have analyzed is the Maryland one, where I have contracted for 4 years for 4 sons.

I suspect it is a good deal because of the options in it. The direct benefit is tuition at any state school (the value varies a little since the tuition differs between schools). They fund this by investing the money they take in and hope it is adequate. They are obviously exposed to market risks since no one knows what returns will be earned.

There is a full choice of university since if the child goes out of state, you get the value of the Maryland tuition, so this one does not lock you in to Maryland universities.

What if the investments do poorly and there is not enough to cover the tuition. The governor must include money in the next budget to make up the shortfall, and it is to be expected it will be appropriated. I figure at worse, the state universities would be told to accept sums in the account (i.e taking a loss on these students).

Thus you have a valuable option.

History shows that forecasts of almost anything several years in the future are not very accurate, so I may benefit from one of these options.

What if the market goes up so the value of the contract exceeds the tuition. You have the option of taking your money out. This plan is a 529 plan, and the value can be rolled over to any 529 plan. They do not publicize this, but if the withdrawal value exceeds the tuition, the smart move is to move the funds to a 529 plan and to pay the tuition from that (any extra money in the plan can be used for other college expenses, or for a later year, or for another beneficiary).

Thus, you have another option here.

Thus, I think the odds are good that this will pay off. I suspect the plan was designed by those that were pro-college education, and oriented towards providing it rather than protecting the interests of the taxpayers.

In Md. you can deduct up to $2500 per type of plan per beneficiary per parent. Between two parents and two types of plans (Maryland also has a T. Rowe Price run plan investing in mutual funds), one can reduce the Maryland taxable income by $10,000 per year per child. Any unused Md. tax benefits can be carried forward for up to 10 years.

There are a lot of payment options (one can contract for either Junior College or University plans), with options for buying anything from a term to several years at a time, and for lump sum payments, and for monthly payments with various down payments, and the rest payable over several years or (for small administrative charges) per month. In my case I have chosen plans to give slightly over 2500 per year per child with a down payment chosen to somewhat exceed $2500, and then three more payments, each of which exceeded $2500.

No one seems to have thought of designing a tax oriented plan, where the down payments were exactly $2500 (instead of 25%, 40%, or 75% of the total cost) and the next annual payments $2500 per year, with the last payment adjusted so the present value at the assumed rate of return came out correct.

The tax forms are not clear (nor are the regulations), but it appears you put down up to $2500 per child per parent or the maximum you had contributed allowed, or a lower amount if you choose (although there are few cases when you might want this). Unlike Federal forms where the laws provide for carry forwards, Maryland does not calculate them for you on its forms (nor does TurboTax). I have left notes to watch for this if I die, because I doubt if the typical tax preparer would think to ask if you had carry forwards, and my wife does not keep up with such details.

I am not certain I have followed the optimal strategy. You pay a $20 fee for each contract with I believe the last date being just before new tuition rates are public. I suspect it would be wise to pay this fee to lock in rates, and then re-examine it when the first payments were due, and possibly even to abandon the plan if it looked like tuition was rising less rapidly than than the actuaries were assuming.

They do not provide the withdrawal value on their websites (but it must be calculated on request), and I suspect that even when it was optimal to tke the money value and put it in another 529 plan I.e. when the money value exceeded the tuition), most would not to think to do so.

I would be curious if anyone else who has examined the Md. plan agrees with my favorable appraisal.

I suspect the politics in other states may have produced a favorable plan for potential students in that state, but each would have to be examined in details, considering all of the possible outcomes (high tuition, low tuition, going to school out of state, death, getting a scholarship, choosing not to go to university, etc.)

Sounds like MD has the key elements of a great plan, but what is not clear is the value.

A great prepaid plan must

Be guaranteed by the state;
Fully transferable at full value even to an out of state school;
Fully valued even in the event of beneficiary death, disability, or scholarship, or the beneficiary does not attend college for any other reason (subject to regular income tax);
Pegged to the tuition inflation rate in such a way to match or exceed the CPI index.

WA is another state with a great plan on all these counts. However, WA no longer provides great value. The cost of a unit is $172 while the payout value is only $118, for an enormous premium of 46%. Thus with 7% annual tuition inflation, it would take almost six years before even breaking even. Such an investment might still be worthwhile for an investor who is both very risk averse and also very exposed to the risks of tuition inflation, but otherwise it is not a good choice at this time.

Note the premium has risen steadily over time, as the unit cost itself has more than doubled in 4 years.

http://get.wa.gov/documents/Unit%20Prices%20Over%20Time.pdf

Finally, note that the WA plan cynically charges its lowest income participants a 7.5% finance charge for all those making scheduled monthly purchases, as opposed to presumably wealthier customers who make single or multiple lump sum purchases.

ProfessorEd said:   I would be curious if anyone else who has examined the Md. plan agrees with my favorable appraisal.Very thorough analysis. It has been a few years since I did this research, and I don't have my notes at hand, so I am going from memory. First, the best choice for a Maryland resident is almost always going to be a Maryland 529 plan. Taxes are so high here that it would be hard to make up that instant return by foregoing the state tax benefit and going with an out-of-state plan.

You’ve also hit on another obscure provision about the state tax benefits. In many states, you can deduct the 529 contributions, say $2,500 per child, but there is a max of $5,000 overall. In Maryland, BOTH parents can set up plans and take the deduction (even if one parent has no income), AND there is no overall cap. For someone who has say, four children, Mom & Dad can both set up plans for each child, contribute $2,500 to each for each child, and the entire $20,000 gets the state tax break. That’s an instant return of about $1,800 that would be capped at a lower amount in most other states.

With respect to the prepaid tuition plan vs. the traditional 529…In the early days of prepaid plans, there were some great bargains. Anyone who bought them – in most states – in the 1980’s got a GREAT value. After that, the state educational systems started going broke and tried to make it up by raising tuition – AND raising the prices on the prepaid plans. When I did the calculation on the Maryland plan a few years ago, I estimated an internal rate of return on the prepaid plan to be just a couple of percent as I recall. I used reasonable assumptions for the expected rise in tuition costs and other fees, and I just thought it did not represent a good return on investment versus expected returns in the traditional 529. I went the traditional route.