How to Rollover a Prepaid Tuition Plan to a 529 Savings Plan
Prepaid tuition plans allow families to pre-pay all or a portion of future college costs at today’s prices (plus a premium) and can act as a hedge against college inflation. But, prepaid tuition plans are more restrictive than 529 college savings plans, and may not be the best option for some students.
Prepaid tuition plans offer the same tax benefits, high contribution limits and favorable financial aid treatment as 529 college savings plans. However, most prepaid tuition plans have state residency requirements and are designed to save for an in-state public college or select group of colleges. Funds typically must be held in a prepaid tuition plan for at least 3 years.
How to rollover a prepaid tuition plan into a 529 savings plan
Families may roll prepaid tuition plan assets into a 529 college savings plan for the same beneficiary or a qualifying member of the beneficiary’s family without federal tax consequences. The funds must be contributed to the new 529 plan or other qualified tuition program within 60 days of the distribution, and rollovers are only permitted once in a 12-month period.
A rollover request, refund or cancellation form, is typically found on the prepaid tuition plan’s website. The amount of the refund that the account owner receives typically includes payments made into the plan and a portion of any earnings in the account. The earnings may be capped. The account owner may have to pay administrative expenses or a penalty fee to cancel a prepaid tuition contract.
Reasons to consider a prepaid tuition plan rollover
- You want a greater return on your investment. Most prepaid tuition plans are designed to protect your principal investment with very little upside potential. 529 college savings plans, however, may be invested in riskier investments, such as equities, that offer greater potential reward.
- Your child plans to attend an out-of-state or private college. Prepaid tuition plans are intended to help save for an in-state public college, with the exception of Private College 529, which allows families to prepay future tuition at one of nearly 300 private colleges and universities. Most prepaid tuition plans offer refunds if the beneficiary attends a different school, but the amount of the refund is usually less than they would have been able to save in a 529 college savings plan.
- Your prepaid tuition plan is not guaranteed by your state. Some states are not legally obligated to back up their prepaid tuition program’s promises, which means your benefits could be reduced if the program becomes insolvent. Only prepaid tuition plans in Massachusetts, Florida, Mississippi and Washington are guaranteed by the full faith and credit of the state.
- You moved to a new state and want to claim a state income tax benefit. Some states offer a state income tax deduction for rollover contributions from an existing qualified tuition plan to an in-state 529 savings plan.
- You want to pay for more than just tuition. Most prepaid tuition plans can only be used to pay for college tuition and fees. 529 college savings plans have a broader range of qualified education expenses, including tuition, fees, books, supplies, and, if the student is enrolled at least half time, room and board. In many states, 529 plans may also be used to pay for up to $10,000 a year in K-12 tuition expenses.
- Your prepaid plan closed. Eight prepaid tuition plans are closed to new enrollment, and some of these plans are closed indefinitely. For example, investors in Tennessee’s BEST Prepaid Tuition Plan are only eligible to remain in the plan if the beneficiary has been accepted into or is currently enrolled in college. If these requirements were not met, families had to roll the funds into another 529 program.
State tax consequences of prepaid tuition plan rollovers
Families who roll prepaid tuition plan funds into a 529 plan in a different state may be subject to state income tax and a 10% tax penalty on the earnings portion of the rollover distribution. Many states also “recapture” previously claimed state income tax benefits when funds are rolled into a 529 plan in a different state.
A good place to start