Maryland offers both a prepaid 529 plan as well as an investment fund plan that, when used together, can diversify your college savings. In the Maryland Prepaid College Trust, you purchase semesters of tuition at today’s prices. No matter how much the cost of tuition increases, you have paid the tuition for the number of semesters purchased. The investment you purchase can be used at Maryland colleges and universities as well as out-of-state and private colleges and universities.
Last week I addressed whether it was wise to contribute more to the Maryland College Investment Plan than the annual deductible amount for Maryland state income tax purposes (which is $2,500 per year for each account owned). In general, it isn’t. The Maryland College Investment Plan is expensive and you are better off making contributions above $2,500/year to the Utah Educational Savings Plan to get lower fees and better investment fund choices and performance.
The discussion below focuses on the merits of the Maryland Prepaid College Trust. The Prepaid College Trust is one way to diversify your college savings and could be used to satisfy the $2,500 annual deduction.
In the Prepaid College Trust you purchase semesters of in-state tuition at four-year or community colleges. The younger your child, the less expensive the semester. The current price for one university semester is $5,535 if your child is a 2nd grader and $5,515 for a first grader ($20 less expensive for the younger child). You are not purchasing room and board; you’ll have to pay for these expenses through other means. You also can buy one to four years of university tuition rather than semesters only.
Maryland also offers prepaid community college tuition. There is a conversion rate between the community college and the university tuition rate which allows your purchases to be used interchangeably.
You also can use the semesters purchased at out-of-state and private colleges and universities. Maryland uses a formula that does not penalize you if your child does not attend a Maryland state school. Your purchase will be worth an equivalent amount toward tuition at a private or out-of-state college as if it were used for a Maryland state school.
Is it a Good Deal?
You are purchasing an asset in the Prepaid College Trust that has the following attributes:
- It grows in value each year, but the rate of return is low. In the example above, the difference in the purchase price for one semester of university tuition between a first and second grader is only $20 on an investment of $5,515. This means the return is 0.36% for one year. You could invest the $5,515 in a one-year CD and earn 1.25%, which is better than the 0.36% return. There are similar difference in the cost of one semester between other years as well that result in an annual return of about 0.50%.
- It is unknown how the price of tuition will increase from year to year. The price of one semester for a second grader next year may be more than $5,535 (this year’s price). You take a risk in that if tuition goes up a lot, you have done well because you paid a lower price for that expensive semester in the future. If tuition is stable from year to year, then your investment isn’t worth as much.
- The semester you purchase is backed by a Maryland legislative guarantee to ensure that the investment will be paid many years in the future. It won’t lose value, which could happen when you invest in a College Investment Plan fund. Although this guarantee is not as strong as FDIC insurance on a CD, it is not bad and better than many other states’ guarantee.
Using the Prepaid College Trust and a College Investment Plan
I like the notion of diversifying your college savings between the Prepaid College Trust and a College Investment Plan, especially the younger your child. Assuming you have one child and one account, the following strategy may help diversify your holdings and reduce your investment risk.
If you have only $2,500 to contribute in any one year, contribute it to the Maryland College Investment Plan to get the Maryland income tax deduction. Even though this plan is expensive, your savings are likely to grow more here than only using the Maryland Prepaid College Trust.
If you have more than $2,500 to invest in any one year, contribute $2,500 to the Maryland Prepaid College Trust and contribute the amount above $2,500 to the Utah Educational Savings Plan (better fund choices and performance compared to the Maryland College Investment Plan).
I like the Maryland Prepaid College Trust because it doesn’t penalize you if your child goes out of state or to a private college and the semester purchased will not lose value. When you execute this strategy you may have to buy one semester at about $5,515 and carryover the income tax deduction into the next two years since you are limited to $2,500 in any one year and it will take three years to complete the deduction at $2,500/year increments. Do not buy more than two or three semesters of the Maryland Prepaid College Trust.
By combining the Maryland Prepaid College Trust and the Utah Educational Savings Plan, you are diversifying your college savings investments. When it comes to cashing the funds to pay for your child’s education you can see which fund has done better and then use that one to fund the tuition bill. In this way you have flexibility when payment is actually made so you are not forced to cash in your investment funds when the market is down.
So spread your college savings between the Prepaid College Trust and the Utah Educational Savings Plan. By diversifying your college savings you are likely to be in a good financial position as your child enters college.