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NEW YORK (CNN/Money) -
Take your best guess: Which will rise faster, the stock market or college tuition?
How you answer that question will help determine whether you should go for a traditional 529 savings plan or the relatively new Independent 529.
Started in September 2003, the Independent 529 is a plan set up by a consortium of 251 private colleges that allow you to purchase tuition credits today for use at a later date at any one of the member schools, which include Amherst, Lake Forest College, Syracuse, Princeton and the Massachusetts Institute of Technology. (For the full list, click here)
Here's the thinking behind the Independent 529: You might contribute $1,000 in 2005 for your newborn at a school where the annual tuition is $30,000. What you have done is buy a tuition credit worth 1/30th of a year's tuition.
If tuition continues to rise at its historical rate of 6 percent a year, in 2023 when your child enters her freshman year, a year of school would cost $85,630 -- and your credit for 1/30th of a year's tuition would be worth $2,854. In effect, you've gotten a 6 percent return on your money.
That's not all. You also get a discount: It varies depending on the school, but on average it's about 1 percent annually -- savings that add up over 18 years of contributions.
How does that compare with state 529 savings plans, in which you save money tax-free in stock and bond accounts? At the end of 18 years, if your money grew at the historic S&P rate of 8 percent a year minus a 1 percent a year maintenance fee, your $1,000 would be worth $3,379, a gain of $2,379, or nearly the same amount saved under the Independent 529 plan once you factor in the discount.
But things could change. The market could deviate from it's historic pattern, as could the pace of tuition increases. And that's where the gamble comes in.
Both plans have low minimums and allow unlimited contributions by an unlimited number of people -- though one person can only give up to $11,000 a year without triggering "gift" taxes.
Enrollment in the Independent 529 plan is done through the group's Web site, www.independent529plan.org, and most people provide a checking account number and set up a monthly automatic deduction program.
Some believe the Independent 529 is the safer investment.
"From a risk standpoint the Independent 529 is certainly a different creature," said Joseph Hurley, founder and chief executive of the Web site savingforcollege.com. "People looking at this program are really looking at it as more of an insurance policy" against the cost of rising tuition.
Risks
Aside from tuition hikes leveling off, the other main risk to the Independent 529 is that your kid won't get into any of the 251 private colleges in the program or will decide not to attend college at all.
In that case, the best thing to do is transfer the plan to another one of your children or yourself, which is allowed.
But in the event you need to cash out of the program, you'll only get back the money you put in, plus an annualized 2 percent gain or loss, depending on how the fund that holds the money has performed. The amount you get back would most likely be far less than if you cashed out of a regular 529 plan that was making 7 percent a year, even after paying the required taxes and 10 percent penalty on your earrings that comes with cashing out of a regular 529.
There also are financial aid implications. For now, the government considers the Independent 529 part of the child's assets while the regular 529 is part of the parents'. That means students could be eligible for less financial aid, though Hurley expects the Independent 529s to be treated the same as a regular 529 when Congress passes a new higher education bill later this fall or early next year.
Hurley said the type of plan he would recommend would depend on the family and child. If you're bearish on the stock market, your kid knows they want to go to a private school and they have a good chance of getting in, then the Independent 529 is probably the way to go.
But if you've got a high tolerance for risk, think the market will perform at least as good as its historical average or your child is leaning toward public schools, then there may be no reason to stray from the standard 529.
For more on the traditional 529, click here.
For a look at the best college cars, click here.
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