|Question: What's the difference between how a college savings plan invests and how a prepaid tuition plan invests?|
The two basic types of prepaid tuition plans are contract plans and unit plans. With a contract plan, you invest your money in exchange for a promise that the plan will pay you a certain amount in future college tuition and fees. A unit plan allows you to purchase units or credits that increase in value each year (similar to an index that keeps pace with rising tuition) and are later redeemed to pay for tuition and other expenses. With both types of prepaid plans, your money is placed in a plan trust fund that also includes the money contributed by other participants in the plan. Professional money managers invest the trust fund assets in investments whose rate of return is expected to cover the future payments owed by the plan.
With a college savings plan, your contributions go into an individual account that's invested in a portfolio of investments (typically mutual funds). Many plans let you choose from a variety of investment portfolios at the time you open an account, allowing you to take into account your risk tolerance and general market conditions. At one time, most plans didn't offer you a choice--your portfolio was simply based on your child's age, and the investments in the portfolio gradually shifted to more conservative ones as your child grew.
But be aware that college savings plans entail risk because your investment returns are not guaranteed. You may even lose some of the original amount you invested. If you're not happy with the performance of your investment portfolio, you may be able to direct future contributions to a different portfolio, depending on the rules of your specific plan. Also, the IRS has given states the discretion to allow you to change the investment option for your existing contributions once per calendar year or at the time you change the beneficiary of your plan. Check with your plan for more details. Keep in mind, too, that you can roll over your college savings plan to a different 529 plan (college savings plan or prepaid tuition plan) once per year without changing the beneficiary. Please note, however, that rollover contributions may not be eligible for a state income tax deduction if your state offers one for 529 contributions. Check with your tax professional for more information.
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.