Saving for college in Texas: prepaid tuition, 529 savings plans and what to fund first

The short version for Texas parents

For most Texas families, the main choices are a 529 college savings plan, which invests your contributions in a mix of funds and can be used at schools across the country, and the Texas Tuition Promise Fund, a prepaid plan that locks in current tuition and required fees at Texas public colleges. The IRS explains that earnings in a 529 plan are not subject to federal tax when used for qualified education expenses. The best plan depends on where your child is likely to go, how much flexibility you want and what else your family still needs to fund first.

I set up college savings for families as one part of a larger plan, and the question I hear most is which account to open. That matters, but in my experience the order of priorities matters more. A college fund built on top of a household with no life insurance and no emergency savings is fragile.

What Texas offers through the state

Texas college savings programs are administered by the Texas Prepaid Higher Education Tuition Board through the Comptroller's office. According to the Board's own listing, it oversees several plans, each with a different purpose. Knowing which is which keeps you from comparing two things that do not work the same way.

Many Dallas parents I meet have heard of one of these and assume it is the only option, or confuse the prepaid plan with the savings plans. They are separate programs with separate rules, separate enrollment processes and separate risks, so it is worth reading the description of each before deciding.

• Texas Tuition Promise Fund: the state's prepaid tuition plan that is open for enrollment
• Texas College Savings Plan: a 529 college savings plan sold directly to families
• Texas LoneStar 529 Plan: a 529 college savings plan sold through financial advisors
• Texas Guaranteed Tuition Plan: the original prepaid plan, now closed to new enrollment
• Texas ABLE Program: a 529A savings plan for individuals with disabilities

Prepaid tuition: locking in today's prices

The Texas Tuition Promise Fund lets Texans lock in current undergraduate tuition rates and schoolwide required fees at Texas public colleges and universities, excluding medical and dental schools, according to the plan's website. You buy units that can cover all or part of those costs in the future. Enrollment runs during a set window each year, from September 1 through the end of February, with a longer window for babies under one year old.

The appeal is predictability if your child is likely to attend a Texas public school. The trade-offs deserve equal attention. The plan states that redemptions at Texas private colleges use a transfer value that can be lower than what the units would cover at a public school, that participation does not guarantee admission and that you may lose money by participating. Contracts are not guaranteed by the Board. Read the plan description carefully before buying.

529 savings plans: flexibility with market risk

A 529 savings plan works more like an investment account dedicated to education. You contribute over time, choose investments and use the money later for qualified expenses. The IRS lists qualified expenses as including tuition, fees, books and room and board at an eligible institution, along with a limited amount of K-12 tuition and certain computer equipment. The account is not tied to Texas schools; the LoneStar 529 Plan, for example, says its funds can be used at most accredited institutions in the United States, including career schools, and at some schools abroad.

The flexibility comes with risk. The LoneStar 529 Plan states plainly that an account could lose money, including the principal invested, and that automatic investing does not assure a profit. That risk is why the investment mix matters and why many families become more conservative as the child approaches college age.

Texas offers its 529 savings plans in two ways. The Texas College Savings Plan is sold directly to families, so you open and manage it yourself. The LoneStar 529 Plan is sold through financial advisors; according to the plan, participants must be U.S. citizens or permanent residents at least 18 years old with a Social Security number, and Texas residency is not required. The right channel depends on whether you want to make the investment choices yourself or have someone help you choose and adjust them over time.

How the tax side works for a Texas family

The IRS explains that earnings in a 529 plan are not subject to federal tax, and generally not state tax, when used for qualified education expenses, but that contributions are not deductible. Because Texas has no state income tax, there is no state deduction for Texas families to chase either, which some families in other states use as a reason to pick their home plan. For Texans, the decision rests on the plan's investments, costs, flexibility and how you prefer to open it.

The IRS also notes that money can be moved to another 529 plan for the same beneficiary or for a member of the beneficiary's family without being taxed. If one child receives a scholarship or chooses a different path, the account may still serve a sibling. Withdrawals for expenses that do not qualify are treated differently, so check the rules with a tax professional before taking money out for anything else.

What to fund before the college account

This is where I sometimes disappoint parents. If the family has no life insurance and a parent died, the college fund would likely be spent on the mortgage and groceries long before anyone enrolled. If there is no emergency fund, a job loss could force you to stop contributions or raid the account. And if retirement savings have not started, the parents may end up depending on the children later, which is the opposite of what a college fund is meant to accomplish.

So my order is protection first, an emergency fund second, high-interest debt third, then long-term saving for retirement and college side by side. I explain that sequence in putting protection and savings in order, and the coverage side in how much life insurance a family really needs, which should account for education costs you have not yet saved for.

Choosing between the two approaches

Neither approach is right for every family. A few questions usually point the way, and you can answer most of them at home before talking to anyone.

Some families use both: a prepaid plan for part of the expected cost at a Texas public school and a savings plan for flexibility, housing and everything tuition does not cover. That can work well, but it is more to manage, so be sure the combination serves a purpose.

• How likely is it that your child attends a Texas public college or university?
• Would you rather lock in tuition costs or keep the flexibility to use the money anywhere?
• How comfortable are you with market ups and downs over the years until college?
• Do you want to open an account yourself or work with an advisor?
• Are you saving for one child or several, and might the money need to move between them?

How much to set aside without a magic number

Parents often ask for a target, and I understand why. But the honest answer is that the right monthly amount depends on how many children you have, how many years remain, what kind of school you expect and how much of the cost you intend to cover. Some families aim to cover everything; others aim for a share and expect scholarships, work or the student's own savings to fill the rest. Decide which kind of family you are before choosing a number.

Then start with an amount you can keep up through ordinary ups and downs, and raise it when income rises. Consistency usually beats an ambitious start that stops after a year. If grandparents or other relatives want to help, ask the plan how outside contributions work, since a birthday gift into a college account can add up over the years.

Mistakes Texas parents make with college savings

The most common is waiting for the perfect amount. A modest monthly contribution started when the child is small has many more years to grow than a larger one started in middle school. The second is opening an account and never revisiting the investments, so the portfolio is as aggressive at seventeen as it was at two. The third is putting college ahead of retirement, which leaves parents short later with no student loans available for their own retirement.

Another is forgetting that a Roth IRA and a 529 plan do different jobs. A Roth IRA is primarily a retirement account; a 529 plan is built for education. If you are weighing the two, the retirement side is covered in opening a Roth IRA on your own.

Starting a college plan with me

I help families around Dallas fit college savings into the rest of their plan: protection, emergency savings, retirement and then education, funded at a monthly amount they can keep up. We talk through the options, the trade-offs and how much to set aside based on your children's ages and your other goals. I am a registered representative of PFS Investments Inc., licensed for investments in Texas and several other states.

Investments carry risk, and no return is promised. If you are deciding whether to work with an advisor at all, the questions I would ask are in what to ask a financial advisor before hiring. A first conversation carries no obligation, and you will leave knowing which approach fits your family and why.

Questions people ask me