In the college savings game, all strategies aren’t created equal. The best savings vehicles offer special tax advantages if the funds are used to pay for college. Tax-advantaged strategies are important because over time, you can potentially accumulate more money with a tax-advantaged investment compared to a taxable investment. Ideally, though, you’ll want to choose a savings vehicle that offers you the best combination of tax advantages, financial aid benefits, and flexibility, while meeting your overall investment needs.
529 prepaid tuition plans
Prepaid tuition plans are cousins to savings plans – their federal tax treatment is the same, but their operation is very different. A 529 prepaid tuition plan lets you prepay tuition at participating colleges, typically in-state public colleges, at today’s prices for use by the beneficiary in the future. Prepaid tuition plans are generally limited to state residents, whereas 529 savings plans are open to residents of any state. Prepaid tuition plans can be run either by states or colleges, though state-run plans are more common.
As with 529 savings plans, you’ll need to fill out an application and name a beneficiary. But instead of choosing an investment portfolio, you purchase an amount of tuition credits or units, subject to plan rules and limits. Typically, the tuition credits or units are guaranteed to be worth a certain amount of college tuition in the future, no matter how much college costs may increase between now and then.
However, if your child ends up attending a college that doesn’t participate in the plan, prepaid plans differ on how much money you’ll get back. Also, some prepaid plans have been forced to reduce benefits after enrollment due to investment returns that have not kept pace with the plan’s offered benefits.
Even with these limitations, some college investors appreciate not having to worry about college inflation each year and want to lock in college tuition prices today. The following table summarizes the main differences between 529 savings plans and 529 prepaid tuition plans:
| 529 savings plans | 529 prepaid tuition plans |
| Offered by states | Offered by states and private colleges |
| You can join any state’s plan (though some plans may require you to enroll with a financial professional) | State-run plans require you to be a state resident |
| Contributions are invested in your individual account in the investment portfolios you have selected | Contributions are pooled with the contributions of others and invested by the plan |
| Returns are not guaranteed; your account may gain or lose value depending on how the underlying investments perform. | Generally a certain rate of return is guaranteed in the form of a percentage of tuition being covered in the future, no matter how much costs may increase by then |
| Funds can generally be used for the full cost of tuition, fees, room and board, equipment and books at any accredited college or graduate school in the U.S. or abroad, or K-12 tuition expenses up to $10,000 per year | Funds can be used only for tuition at participating colleges (typically state colleges); room and board and graduate school generally are not eligible expenses |
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