Virginia is one of many states that offers both a prepaid 529 plan as well as an investment fund plan. In the PrePaid Plan, you purchase semesters of tuition at Virginia Public institutions at today’s prices. No matter how much the cost of tuition increases in at these in-state colleges in the future, you have paid the tuition for the number of semesters purchased. The investment you purchase can be used for private Virginia institutions and out-of-state institutions as well.
The other plan is the InVest Plan, which offers stock and bond mutual funds. The investment earnings are not taxed (both federally and at the state level) as long as you use them for qualified higher education expenses (tuition, room and board, fees, etc.).
Last week I addressed whether it was wise to contribute more to the Virginia InVest 529 Plan than the amount deductible for Virginia state income tax purposes (which is $4,000 per year for each account owned). In general, it is but with a suggestion to consider investing in the low-cost static investment funds rather than the more expensive age-based investment funds.
The discussion below focuses on the merits of the PrePaid Plan and how it could be used in some situations to guard against tuition increases at Virginia public institutions. The PrePaid Plan, however, is probably not the best choice for most parents saving for their children’s college education.
In the PrePaid Plan you purchase semesters of in-state tuition at four-year Public Institutions. The younger your child, the more expensive the semester. The current price is $8,100 for children under the age of 5. It is $7,500 for 5th through 9th graders.
You are not purchasing room and board; you’ll have to pay for these expenses through other means. In-state Public Institutions include, for example, the University of Virginia, Virginia Tech, College of William and Mary, James Madison University among others.
You also can purchase semesters of tuition at Virginia community colleges. Community college semesters are less expensive than four-year college semesters. The cost is $3,100/semester for children in the 9th grade or below.
There is a conversion rate between the community college and the four-year public institution tuition rate which allows your purchases to be used interchangeably. One semester at a four-year public institution equals 2.6129 of community college semesters. If you buy four-year college semesters they can also be used at community colleges using the conversion rate (and vice versa).
Virginia Private Institutions
Your four-year public institution semesters can also be used at Virginia Private institution, however, the PrePaid Plan’s conversion rate is not favorable to you. Virginia Private Institutions include, for example, Lynchburg College, Marymount University, Hampden-Sydney College among others.
The semesters you purchased at in-state four-year public institutions can be applied to Virginia Private Institution tuition using a formula that is either the lesser of 1) the payment made under the Contract (e.g., your contributions) plus the “Actual Rate of Return” earned by prepaid on the invested funds or 2) the highest-in state undergraduate Tuition at a Virginia Public Institution in the same semester.
This formula is a mouthful. It means that when you use your purchased semesters at Virginia Private Institutions they won’t be valued as much compared to the highest or even the average Virginia Public Institution tuition. This disadvantageous feature is very limiting factor. If you aren’t sure whether your child will attend a Virginia Public Institution, the PrePaid Plan may not be beneficial to you.
The semesters you purchase also can be used for the out-of-state tuition, but the conversion rate is not as favorable to you as if they were for used for in-state tuition. The semesters purchased will pay to the out-of-state institution the lesser of 1) the payments made on the Contract plus interest as the composite Reasonable Rate of Return or 2) the average in-state undergraduate Tuition at Virginia Public Institutions for the same academic semester the semesters are used.
The upshot is the amount of prepaid benefits for out-of-state institution is likely to be less than the average Virginia Public Institution tuition. Again, this conversion features makes these investments less attractive for students not attending Virginia Public Institutions.
Which is Better? The InVest Plan or the PrePAID Plan?
At best, the PrePAID Plan can be used as a hedge to lock in today’s tuition prices. It mitigates some of the risk inherent in the stock and bond funds available in the InVest Plan. It is a low-risk investment, especially if you know your child will be attending a Virginia Public Institution.
The downside is that there are substantial drawbacks if your child does not attend a Virginia Public Institution.
One possible approach is to contribute to the InVest program to obtain the most substantial growth in your funds when your child is a youngster. If your child expresses interest in Virginia Public Institutions then it may make some sense to purchase several PrePAID semesters. Remember: the Virginia prePAID plan is only for tuition so you will have to come up with additional money anyway, which is where the money in the InVest Plan can be used.
If your child does not express interest in Virginia Public Institutions then the PrePAID Plan is an expensive investment. You are likely better off contributing solely to the InVest Plan’s conservative investment funds rather than to the Virginia 529 PrePaid Plan.