By KATHLEEN PENDER
San Francisco Chronicle
14-NOV-05
To help parents and generous grandparents cope with the soaring cost of higher education, a consortium of private colleges is offering a savings plan that guarantees tomorrow's tuition at slightly less than today's rates.
It's called the Independent 529 Plan. It covers tuition and fees at more than 250 private schools nationwide, including Stanford, Princeton and the Massachusetts Institute of Technology.
The plan could be a good option if you're pretty sure your child will attend one of the participating schools and think tuition will rise rapidly. If your child ends up going elsewhere, or nowhere, you can get your money back, adjusted slightly up or down depending on the fund's performance.
It works like this:
You open an account, name a child as beneficiary and invest some money. The money buys a certificate good for a certain percentage of a year's tuition and fees at any participating school.
The percentage varies by school, based on its tuition and the discount it offers. Each school must discount its tuition for participating families by at least half a percent per year. The average is 1 percent and the discount compounds each year.
When the child starts school, the certificate can be redeemed _ tax-free _ for the same percentage of tuition at any participating school. The plan does not guarantee admission to any school.
Suppose you invest $20,000 today. That will buy roughly one year of tuition and fees at Texas Christian University or two-thirds of a year at Stanford.
When the child starts school, it will buy roughly the same year of tuition at TCU or two-thirds of a year at Stanford. It doesn't matter what the actual tuition is then or how much your investment has earned.
Money in the plan is deposited in a trust account and managed by TIAA-CREF, a large financial institution that manages pension plans for university employees.
If your child attends a participating school, your return on investment will be the rate of inflation in that school's tuition.
For example, if the student attends Stanford, and Stanford's tuition has risen 5 percent a year on average, your return will be 5 percent a year, plus the discount.
Over the past decade, the total cost of attending a four-year private school has increased at an average rate of 5.3 percent a year, or 2.8 percent a year after inflation, according to the College Board.
For this academic year, the average private school charges $21,235 in tuition and fees. Room and board typically adds an extra $8,000 or so. The Independent 529 cannot be used for room and board.
The Independent 529 is named after the section of the tax code that created tax-sheltered accounts for college savings. Originally, the accounts only sheltered the money from federal tax while it was accumulating. In 2001, the law was amended to allow federal tax-free withdrawals if the money pays for qualified college expenses.
There are two types of 529 plans:
Prepaid tuition plans. Prepaid plans are guaranteed to rise in value at the same rate as college tuition. Originally, prepaid plans could only be offered by a state and used to pay expenses at in-state public schools. Fifteen states now offer one.
The 2001 tax law lets individual schools (or groups of schools) offer prepaid plans. The Independent 529 is the only one started thus far.
529 college savings plans. These plans can only be offered by states, and every state sponsors at least one.
In a 529 savings plan, you put in a sum of money and choose how to invest it. Most plans offer a limited selection of mutual funds. When your child starts college, you can use the money to pay for tuition and fees at any qualified two- or four-year institution public or private in any state.
The savings plan is more flexible than the prepaid plan, but it's also riskier. Your ability to pay for college depends on how your investments fare and how fast tuition increases.
By comparison, in a prepaid tuition plan, the colleges take the market and inflation risk.
If a prepaid plan's investments grow faster than tuition, the schools (or state governments, in the case of state plans) get the excess return. But if tuition grows faster, they eat the difference.
The state-sponsored prepaid plans "were popular when they first came out," says Joe Hurley, founder of Savingforcollege.com.
They went into a lull in the late 1990s, when people thought they could make more money in stocks. After the market crashed, prepaid plans became popular again, so popular that some have stopped accepting new money because "their investment returns can't keep up with their own tuition increases," says Hurley.
At the Independent 529 Plan, "our interest is covering the cost of tuition, not making money off the program," says Phillip Doolittle, senior vice president of finance and administration at University of Redlands. The Southern California school was a founding member of the plan.
"We've done a lot of modeling back and forth. There are scenarios where money can be made or lost. We've designed some things so that it creates a rainy-day fund, a way of subsidizing so the college wouldn't get hurt," he adds.
If you invest in the Independent 529 plan and your child does not attend a participating school, you have three options.
You can cash it in, use it for another member of your family or roll it into a 529 college savings plan and then use the money to pay for tuition, room and board at any school, public or private.
If you cash it in or roll it over, you will receive your original investment, plus whatever earnings it has accumulated but _ by law _ not more than 2 percent per year. If your investment has lost value, you could lose money, but not more than 2 percent a year.
If you cash it in and don't spend it on college, you will owe tax and a 10 percent penalty on your earnings. If you cash it in and use it at a nonmember college, transfer it to another family member or roll it into a 529 savings plan, you will maintain the favorable tax treatment afforded 529 plans.
Unless Congress changes the law, the Independent 529 Plan could make it harder to get financial aid.
Money you have saved in a prepaid tuition plan essentially reduces your aid dollar for dollar.
Other non-retirement assets _ including those in a 529 savings plan _ generally reduce aid by about 6 cents per dollar saved (if it's in the parent's name) or 35 cents (if it's in the student's name).
(E-mail Kathleen Pender at kpender@sfchronicle.com.)
(Distributed by Scripps Howard News Service, www.shns.com.)
