Synopsis: State-sponsored prepaid tuition plans, which are available in many states, allow you to pay tomorrow's tuition bills at today's tuition rates. In addition, they allow tax-free withdrawals on earnings if the money is used to pay for qualified education expenses. Parents come out ahead if tuition costs rise faster than the average and would do worse if college costs did not rise as fast. Additionally, grandparents and other relatives -- who may be unsure as to what they should buy as gifts -- can also contribute to the plan. However, returns under such plans may not stack up to returns you may receive in other investments, such as stocks over the long term.
For parents planning for their children's college education, there are several investment options to consider. One option is state-sponsored prepaid tuition plans. These plans allow parents to pay today's tuition rates with the assurance that the child will have the money to go to college when the time comes. They also allow participants to defer paying federal income tax on earnings until money is withdrawn for college.
How Plans Work
Essentially these plans allow parents (and relatives) to "buy" tuition for the child at a fixed price. You either pay in full or pay in installments and you are guaranteed that your investment will keep pace with rising college costs. Depending upon the number of years you have until your child first enters college, your cost may vary.
Since the plans work in part as insurance against rising college costs, there is some degree of speculation involved. Parents come out ahead if tuition costs rise faster than the average and would do worse if college costs did not rise as fast. Historically, tuition costs have risen, keeping pace with inflation and sometimes outpacing the inflation rate. The other hidden benefit is that grandparents and other relatives who may be unsure as to what they should buy as gifts can also contribute to the plan.
Questions to Ask
Is it transferable? To whom? When?
What is the enrollment period?
What costs are covered?
Can out-of-state residents participate?
What happens if you stop paying?
What happens if your child goes to a private college?
What happens if your child goes to an out-of-state college?
What is the tax effect?
Pros and Cons
Plans allow you to lock in tomorrow's college costs today.
Assets held in prepaid tuition plans are attributed to the account owner, not the beneficiary (student), which results in a lower impact on need-based financial aid.
Some state plans offer additional tax advantages.
Plan returns may not stack up to returns you might receive in other investments, such as stocks.
Plans may have limited flexibility. If your child chooses to go to an out-of-state or private college, he or she may
receive only some of the benefits. If you want to transfer the amount to a sibling, some plans may disallow it. If your child decides not to go to college at all, or you choose to withdraw money for some other expenditure, you may face very strict refund policies.
Many plans impose a heavy penalty for withdrawing money for any reason other than college tuition.
Although prepaid plans may not fit every situation's need, they offer benefits to many parents. It may be to your advantage to learn more about these options.