What is the prepaid tuition fee plan?

Definition and Examples of Prepaid Tuition Plans

A prepaid tuition plan is a type of 529 plan that allows you to pay for future educational costs that the beneficiary will incur. A prepaid tuition plan is a type of 529 plan that allows the account holder (known as the saver) to purchase units, credits, or a certain number of years of tuition at participating schools to cover the future education expenses of the beneficiary student. Qualified expenses include tuition and mandatory fees but not room and board or tuition for elementary or secondary schools. These plans are typically sponsored by states or governmental agencies, but some private colleges and universities also support them.

How Prepaid Tuition Plans Work

With rising college costs, it’s more important than ever for parents to start saving for their children’s education expenses early if they have the means to do so. In an effort to make school costs more manageable, some states offer prepaid tuition plans designed to reward savers for planning ahead.

The essence of a prepaid tuition plan is that it enables the saver (parent, grandparent, or another guardian) to pay for future expenses that the beneficiary (usually the student) will incur at some point in the future at today’s prices, thereby protecting against tuition inflation. Savers can pay those expenses as a lump sum or in installments that they contribute to the plan to pay for units, credits, or a certain number of years of tuition (ranging from one year to five years). Schools can range from two-year community colleges to four-year undergraduate programs (and in some cases, graduate tuition). The plan pools the funds and typically invests them according to a long-term investment strategy. The funds are then directly transferred to the participating university when the student starts college.

For example, let’s assume that Jillian and Kun Ying live in Texas and have a five-year-old daughter named Lian. They want to pay for Lian’s education in the University of Texas system while minimizing costs to achieve other financial goals. They open a prepaid tuition plan, name Lian as the beneficiary, and choose a monthly installment payment plan where they contribute money to the plan each month for four years of college tuition at a much lower cost than they expect it to be when Lian becomes a college student. Lian chooses to attend the University of Texas at Austin, and when she turns 18 and starts college, the money her parents have put into the prepaid tuition plan is sent directly to the university.

Requirements of Prepaid Tuition Plans

Since most prepaid plans are state-sponsored, they are often only available if the saver or beneficiary is a resident of the state. Moreover, not every state offers a prepaid tuition plan. States that provide a prepaid tuition plan that still accepts enrollees are Alaska, Florida, Illinois, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas, Virginia, and Washington.

Furthermore, participating schools where units can be purchased are typically restricted to public colleges and universities. If the beneficiary does not attend a participating school, the amount may be paid but at a lower amount.

Finally, some plans allow enrollment only during a specific time of year, and only if the beneficiary meets certain age or grade limits.

If you think you meet these requirements, visit the National Association of State Treasurers’ “529 Plan in My State,” which provides information about prepaid tuition plans and education savings plans in each state along with links to plan websites where you can enroll.

Advantages

Disadvantages of Prepaid Tuition Plans

Advantages:

1. Protection Against Tuition Inflation: The main advantage of a prepaid tuition plan is that you can pay for tomorrow’s expenses at today’s prices, and you can generally be confident that those prices will be sufficient to cover the beneficiary’s education. In fact, most states guarantee that the money in the plan will keep pace with tuition costs. Some states that do not offer these formal guarantees often have other measures at the state level, such as using appropriations to assist in refunds if the plan fails.

2. Tax Benefits: Many states offer tax benefits for contributions to 529 plans such as prepaid tuition plans, such as deducting contributions from state taxable income, but in some cases, only if you are a resident of the state. If you use withdrawals for qualified education expenses, you may also qualify for tax-free growth on the earnings from your investments, which in some cases applies to federal and state income taxes.

3. High Contribution Limits: Each state sets contribution limits for prepaid tuition plans, but the limit is usually the amount required to pay for the necessary tuition units, credits, or years. Therefore, you can often contribute a significant amount to accumulate savings over time. If you are confident that your child will attend an in-state school, these savings can be used to pay for tuition and offset any unexpected college costs.

4. Ability to Recover Original Investment or Withdraw Funds: If you move or the beneficiary decides to attend a school out of state, you can often recover your original investment (but not the growth).

Disadvantages:

1. Geographic Limitations: Because the money you save can typically only be used in certain states, by state residents, and at public colleges and universities, it may limit your child’s future educational options. This is also a drawback if you believe your family may relocate in the future.

2. Limited Use of Plan Funds: Prepaid tuition plans typically do not cover housing and food costs, so you may have to pay the bill for other expenses at higher rates tomorrow.

3. Additional Costs: These plans may charge registration or application fees in addition to ongoing administrative fees that can be a financial burden if not planned for in your budget.

4. Tax Penalties for Nonqualified Withdrawals: If you do not use withdrawals for qualified education expenses, you may be liable for federal income tax and state income tax in addition to a 10% penalty on the earnings.

5. Lack of Financial Backing for Plans in Some States: Some states provide no formal or informal guarantee that a prepaid tuition plan will cover your educational plan if it fails. This means that despite your savings, you may still be responsible for education costs when it’s time for the beneficiary to start college.

Prepaid Tuition Plans vs. Education Savings Plans

An education savings plan is another type of 529 plan, but it differs significantly from a prepaid tuition plan. In particular, a prepaid tuition plan is a state-backed plan where the plan invests your money according to its strategic goals, while an education savings plan is similar to a traditional investment account where you have more control over your investment strategy.

Unlike the strict residency requirements and participating schools in prepaid tuition plans, an education savings plan can generally be used at any public college or university, and possibly even out of the United States. The definition of qualified education expenses is also broader and includes tuition, mandatory fees, housing, and food. It can even be used to cover up to $10,000 in tuition at elementary and secondary schools. This makes an education savings plan more suitable for those seeking geographic or educational flexibility, while a prepaid tuition plan is a more suitable option for those who know they will reside and receive their higher education in a state that offers a prepaid plan.

Conclusions

Main

The prepaid tuition plan is a type of 529 plan that allows you to pay for units, credits, or years of tuition at a participating school. Parents or savers living in one of the 12 states that offer these plans must open accounts and designate the students whose educational expenses the plans will cover. The plans act as a hedge against inflation and come with tax benefits, including tax-free growth of earnings, but they are less flexible than education savings plans, making them more suitable for beneficiaries who meet residency requirements and plan to attend college in-state.

Source: https://www.thebalancemoney.com/what-is-a-prepaid-tuition-plan-4154582