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Is there a prepaid 529 plan in your future?
Prepaid college plans have attracted a lot of press lately — some good, some not so good.
Some articles have extolled their benefits and recommended them as a safe alternative to underperforming 529 savings plans. Other articles have warned that prepaid plans are running out of money and may not be able to deliver the benefits promised to their participants.
Here's some help in figuring it all out:
What is a prepaid plan?
A prepaid plan is a program that allows you to pay money now to be used for future college expenses. Prepaid plans come in several forms, and in comparing plans you will find many differences. For example, some prepaid plans cover tuition and fees only, while others cover all qualified higher education expenses. The essential benefit is that you lock in those costs: Once you've paid the plan's price, it becomes the obligation of the plan to deliver the promised benefits down the road.
Savingforcollege.com groups prepaid plans into three categories:
- "Contract" plans — These allow you to prepay tuition for a number of semesters or years at an in-state, public, four-year or two-year institution. (Think futures contract.)
- "Unit" plans — These allow you to purchase fractional units (typically 1 percent of one-year's tuition) that are redeemable in the future based on average tuition rates at a target group of schools. (Think tuition index fund.)
- "Voucher" plans — These allow you to prepay a specified percentage of tuition at participating schools. (Think percentage-off coupon.)
Where do you find them?
Twenty states operate prepaid plans. Of these, 19 are 529 plans. The Massachusetts U.Plan is a prepaid plan that is not a 529 plan, which means that none of the special 529 rules applies to its participants. That can be good or bad, depending on the particular rule. The U.Plan utilizes Massachusetts general obligation bonds, so the earnings are federally tax-free whether or not used for college. For Massachusetts residents, the earnings are also state-tax free.
In addition, there is one non-state-sponsored 529 plan: a consortium of private colleges, located across the country, operating a prepaid tuition plan called the Independent 529 Plan. Your prepaid dollars can be used at any of the member colleges.
Of the 21 prepaid plans, only 15 are accepting new applicants. The rest have closed enrollment more or less permanently and exist only to pay benefits for their current participants.
Of the 15 plans still open, 11 have state residency requirements. Anyone can use the other four, although you would most likely consider joining one of these four plans only if you expected your child to attend a certain college or one of a certain group of colleges.