Saving for College in Texas: Texas Tomorrow Fund vs. 529 Plan

It’s graduation season, and if your Facebook feed looks anything like mine, it's full of happy kids in caps and gowns, graduating and moving on to the next phase of their lives.It’s an exciting time with much to celebrate.  But it also raises a lot of questions about college and (gulp) how to pay for it.To keep it simple, in Texas you generally have two options: (a) the Texas Tuition Promise Fund^sm, or (b) a 529 savings plan.With the Texas Tuition Promise Fund^sm, you’re basically locking in today’s tuition prices by buying “tuition units” to be used at a future date.If your child goes to a public college or university in Texas, you save the difference between today’s cost and the future cost. How much is public tuition in Texas expected to rise? According to data collected by the Texas Tribune, tuition at UT-Austin increased by an average of about 7.3% per year between 2002 and 2015. Other campuses were a little higher or a little lower, but I think it’s reasonable to assume the trend will continue.There are downsides to a pre-payment plan. First, if your child goes out-of-state or attends a private university, your units won’t be worth full-price. Second, the units can only be used towards undergraduate tuition (not room & board, not grad school). Third, you could potentially earn more by investing the money in a mutual fund with a healthy allocation to stocks.The structure of a 529 savings plan is quite a bit different. The account is similar to a Roth IRA, except that distributions from a 529 are used to pay tuition, room & board, and other qualified educational expenses.The 529 has an owner (usually a parent) and it also has a beneficiary (usually a child). Post-tax contributions are made to the account, then the owner chooses how to invest the money (you are given a menu of mutual funds to choose from). When the money comes out of the account to pay for qualified higher education expenses, distributions are tax-free.Distributions from 529s can be used at nearly any college in the U.S., public or private. You can use the money to pay for tuition, but also for on-campus room and board, graduate school, and other specific education-related expenses (the IRS has a list in this PDF, see p.57). And, like the prepaid tuition plan, if the original beneficiary doesn’t use up all the money, you can change the beneficiary to a sibling, another relative, or even yourself.There are some downsides, here, too. First, you have to choose the investments in the 529, and assuming you want your investments to outpace tuition inflation, that means a healthy allocation to stocks. For people with a low risk-tolerance, a 529 may not be the best choice. Second, if you take the money out for non-education related expenses, you’ll owe taxes on the earnings, plus a 10% penalty.So which is the best choice? As usual, I’m going to punt this question back to you. What are you trying to do?Personally, I prefer the flexibility and the higher upside of the 529 plan. I went to college out-of-state, so I can see my daughters doing the same. I also went to private university, so there’s that, too. But if you know your child will attend a public university in Texas, then the Texas Tuition Promise Fund probably has a better risk/reward profile.Next month, I’ll be sending a follow-up post on my own personal, professional and somewhat controversial view on where saving for college should fall within a family’s priorities. In the meantime, congratulations to all the recent graduates in your life!