Pre-paid Tuition Plans – Is it Smart to Buy In?

What is A Pre-Paid Tuition Plan?

A pre-paid tuition plan is an account to save to pay for college. It’s similar to a 529 in that the money you put into that account is now ear marked to pay for qualified education expenses, but a pre-paid tuition plans works very differently.

How Does a Pre-Paid Tuition Plan work?

These plans are based on the CURRENT cost of tuition. You buy “units,” or “credits,” of tuition at the current cost of tuition that you cash out when your child is ready to go to college and it covers the cost of the tuition in the future, which will probably be more than the current price tag. You

Do I Have to Pay Taxes on the Amount in a Pre-Paid Tuition account?

Once you put money into your pre-paid tuition plan, the money is earmarked for qualified education expenses.  These expenses are defined by the IRS and typically include tuition and fees, room and board, and books, and recently added a computer.

If you pull the money out of the plan you will pay tax on the earnings and a 10% penalty. If the funds are used for qualified education expenses you will pay no taxes on the earnings, no taxes on any gains of your unit value, and you don’t pay money on the gain when you actually take it out to pay for college.

Are There Different Plans?

Pre-paid tuition plans are based totally on your state of residence.  You are only eligible for YOUR STATE’S pre-paid tuition plan.  Not every state has a pre-paid tuition plan anymore.  Some states have discontinued their pre-paid tuition plans or stopped allowing new applicants because many plans have started to run out of funding due to low stock market returns and the rise of college costs.

If your state offers a pre-paid tuition plan, please look into the specifics of how it is run to make sure it is the right fit for your family. Here is a list of the states that still have pre-paid tuition plans.

Differences Between 529 Plans and Pre-Paid Tuition Plans

One of the big differences is that pre-paid tuition plans are ONLY for students who reside in the state the plan is offered.  You can’t live in Oregon and buy into the Washington State pre-paid tuition plan.  Most states have a 529 plan and anyone can invest in it.  You do not have to be a state resident in order to invest in that state’s 529 plan.

In a pre-paid tuition plan you purchase units or credits for future tuition, but in a 529, your money is invested in a portfolio of your choice.

Finally, pre-paid tuition plans usually cover only tuition (hence the name), where 529 plans still have specific rules about what counts as an educational expense, but are a bit less restrictive than a pre-paid tuition plan.

It’s important to understand if a pre-paid tuition plan is the right vehicle for you for college savings.  Weigh the pros and cons of your state’s pre-paid tuition plan and compare it to your state’s 529 plan.

You may find neither of these options are suitable for your family.  Do the research, think about your goals for your children’s future education, and decide on something that feels right for you.  Remember, you are doing the right thing by starting to save NOW!