Prepaid Tuition Plans
The other type of 529 plan is the prepaid tuition plan. Prepaid tuition plans allow college savers to purchase credits at participating colleges and universities for future tuition and sometimes room and board. Tuition costs are purchased at today’s prices for use in any future year, when tuition costs will most likely have increased. Prepaid tuition plans may be bought in one lump sum or in annual installments. Most are sponsored by state governments and have state residency requirements, meaning either the owner or the beneficiary must be a state resident. Many colleges and universities sponsor prepaid tuition plans as well.
State-run prepaid plan funds must be used for in-state public colleges, while funds in a private college 529 may be used only for member colleges. If a beneficiary chooses a school outside of the plan’s coverage area, the funds can be rolled over to another sibling attending an eligible college, or the principal can be withdrawn. Prepaid tuition plans typically charge enrollment and administrative fees. In addition, several prepaid plans have closed, so investors should determine what happens to their funds if the plan closes.
Prepaid tuition plans are typically trusts that are managed by the state. When a contribution is made, the amount is added to the trust’s general account. Investors do not have investment options to choose from, so the investor does not bear the investment risk. Additionally, prepaid tuition plans are often guaranteed by the state. This is in contrast to 529 plans, which are subject to investment risk and offer no guarantees.
Prepaid tuition plans are not subject to inflation risk, because tuition units are purchased at today’s prices. Sometimes we say that prepaid tuition plans provide a good hedge against inflation risk.
Like college savings plans, earnings from a prepaid tuition plan are not subject to federal taxation, as long as withdrawals are made for qualified ed