529 prepaid tuition plans are a type of 529 plan where you can prepay your child’s future college tuition and some other education expenses. Although they’re more restrictive than 529 savings accounts, prepaid plans let you lock in tuition rates for the future, which could represent significant savings over time.
Along with savings plans, prepaid tuition plans make up the two main types of 529 plans, and understanding both kinds of plans and their key differences will help you to decide which will be the most beneficial for your family, and help you to pay for college.
What Is a 529 Prepaid Tuition Plan?
Prepaid tuition plans let you pay in advance for future college tuition and fees at the current rate, by purchasing units or credits. You can choose to pay for each unit as a lump sum or make regular installments to pay it off. Once you’ve made this purchase, the plan administrator invests the money on your behalf. When your child goes to college, you can withdraw these funds and are guaranteed to cover their tuition. The credits can also be transferred to another child in your family.
Eligible expenses under a 529 prepaid tuition plan are limited to tuition and fees: you can’t use this kind of plan to pay for other expenses related to your child’s education such as supplies, equipment, and room and board. Most 529 plans are offered through state governments, and only to the residents of that state.
The key features of prepaid tuition plans are:
- Contribution Limits: Maximum aggregate limits depend on your state
- Covered Expenses: Tuition and mandatory fees
- State Guarantees: Most states guarantee that the funds will cover tuition, and some back these with the credit of the state
- Residency Requirements: You need to be an in-state resident
Tax Benefits of Prepaid Tuition Plans
Prepaid tuition plans come with a number of tax advantages. You won’t need to pay tax on the withdrawals as long as you use them for qualified expenses, or pay tax on your earnings in the plan as they grow. Like 529 savings plans, 529 prepaid plans let you make contributions with your after-tax income, giving you both state and federal tax advantages. Neither will you pay tax on your account’s earnings, nor on qualified withdrawals.
Advantages of 529 Prepaid Tuition Plans
Prepaid tuition plans have a number of benefits, and can be a great way to ensure you can cover your child’s college tuition and expenses. Let’s take a look at the key advantages of these kinds of 529 plans.
1. Offers Similar Benefits to Regular 529 Plans
18 of the prepaid tuition plans (all but Massachusetts’s U. Plan) are 529 plans. That means your earnings will grow tax-free and will not be taxed when you withdraw as long as the funds are spent toward qualified higher education expenses. And just like 529 college savings plans, prepaid tuition plans have very high contribution limits. These limits are determined at the state level and are generally based on the student’s expected future college costs. Contributions are also considered gifts for tax purposes, so deposits up to $15,000 per year per individual will qualify for the annual exclusion (in 2020). What’s more, if you elect to treat your gift as if it were made over a five-year period, as much as $75,000 will qualify.
Prepaid plans also receive the same favorable financial aid treatment as savings plans. Accounts owned by a parent or dependent student will be considered a parental asset on the FAFSA, which means they are assessed at up to 5.64%, versus other student-owned accounts, such as custodial accounts, which are assessed at 20%. That means if one student has $10,000 saved in a prepaid 529 plan it can potentially reduce his aid package by as much as $564. But if he instead saved $10,000 in a UGMA/UTMA account his aid package could be reduced by $2,000.
Starting with the 2024-25 award year, distributions from a 529 plan owned by a grandparent or other loved one will no longer be counted as student income, so there will no longer be a financial aid consideration for accounts owned by someone other than the parent or student.
2. You Can Lock in Future Tuition Costs Today
Rising tuition prices aren’t exactly the latest news. According to the College Board’s Trends in College Pricing 2019 report, the costs of attending colleges and universities have gone up. In fact, since last year, tuition at public two-year, public four-year (in-state), and private four-year has risen by 2.8%, 2.3%, and 3.4%, respectively. Prepaid tuition plans can help hedge against college inflation by letting savers lock in future tuition at current rates.
3. You Won’t Lose Your Money if Your Child Attends a Different School
While prepaid plans are typically designed to pay for tuition at a certain school or school, the funds can usually be transferred or refunded in case your child chooses a different school. For example, if you’ve been saving with the Private College 529 Plan but your child has her heart set on a public university, you have the option of changing the beneficiary or collecting a refund based on the value of the assets in the trust, with a maximum gain or loss of 2% per year.
Or let’s say you’re a Florida resident and you’ve been contributing to the Florida Prepaid College Plan, but your daughter wants to attend Notre Dame. Not to worry – the plan’s benefits can be applied toward any eligible postsecondary institution unless the school elects not to participate.
Disadvantages of 529 Prepaid Tuition Plans
Although 529 prepaid tuition plans can be very beneficial, they also have their downsides. It’s important to understand the disadvantages of prepaid tuition plans to work out if they’re right for you.
1. Prepaid Plans Don’t Cover as Many Costs as Regular 529 Plans
529 college savings plans can be withdrawn tax-free to pay for qualified higher education expenses, which include tuition, fees, supplies and equipment, computers, internet access and even some room and board. Prepaid plans, on the other hand, usually only cover the costs of tuition and fees.
2. Prepaid Plans Aren’t for Everyone
With the exception of the Massachusetts U.Plan, all of the state-sponsored prepaid 529 plans are only available to residents. So if you live in California, for example, you would have to decide on an alternate way to save for a public university (such as a 529 college savings plan). The Private College 529 Plan does not have a state residency requirement.
3. Prepaid Plans Have Limited Enrollment Periods
The Private College 529 Plan offers year-round open enrollment, but other plans are only available during specific months of the year. Florida’s Prepaid Plan typically has an enrollment period from October through February.
When to Use a 529 Prepaid Tuition Plan
Generally, prepaid tuition plans are best for families who are fairly sure their child will go to one of the eligible universities in their state. If you’re not sure what school your child will attend in the future, you may be better off considering a 529 savings plan, which offers many of the same tax advantages, but can be used to cover eligible expenses at any college across the country.
Having said that, if you invest in a prepaid plan and your child decides to attend a school elsewhere, or not go to college at all, you can transfer the credits to another child in your family, so this can still be a good option if you’re confident at least one of your kids will go to school in-state.
Prepaid plans can also be a good choice if you don’t want to invest your education savings. Under this kind of plan, the funds are guaranteed by your state, rather than tied to the stock market. Although 529 savings plans offer a range of portfolio options and are generally low risk, the risk is even lower for prepaid plans: as long as the state’s funding is secure, you’ll be guaranteed that your funds will be there.
Finally, it’s worth noting that all 529 plans are only suited to families whose children end up going to college. These plans are relatively-restrictive in that they can only be used for costs related to your child’s college education. If you’re not certain your children will attend college, you may be better opting for a more flexible option like Coverdell ESAs, which can be used to pay for college or basically anything you want.
Prepaid Tuition Plans vs. College Savings Plans
Compared to a prepaid tuition plan where you purchase units or credits for future tuition, under a college savings plan, you invest your funds in a portfolio of your choice. Therefore, while under a savings plan you rely on the performance of your investment portfolio, a prepaid plan guarantees you’ll be able to withdraw enough funds to cover a certain amount of credits or units.
Most prepaid plans are state-sponsored and have strict residency requirements, while 529 savings plans don’t have any residency restrictions, and are not state-sponsored, though maybe FDIC-insured. Finally, prepaid tuition plans are more restrictive: you can only use them to cover tuition and mandatory fees, while eligible expenses for 529 savings plans include not only tuition, and fees, but also room and board.
Which States Offer Prepaid Tuition Plans?
There are currently 18 state-sponsored and one institution-sponsored prepaid plan, the Private College 529 Plan. However, only seven of these are currently accepting new applicants, and many have residency requirements. Therefore, it’s important to check the plan details to make sure it’s suitable for you.
These states are accepting new applications for 529 prepaid plans, during their specified enrollment periods:
Why States Have Dropped Prepaid Tuition Plans
There are a number of states that used to offer prepaid tuition plans but have since discontinued their programs or closed them to new applicants. Reportedly, this was because in the early 2000s many plans started to run out of funds. It seems that the combination of rising tuition and a weaker stock market has made it less viable for states to sponsor these programs, and so many decided to opt out entirely.
The Bottom Line
529 prepaid tuition plans can be a great way to pay for your child’s college education. Prepaid tuition plans offer a high level of security, and allow you to lock in the cost of your child’s future education. However, they are more restrictive than 529 savings plans, being limited to tuition and mandatory fees for eligible colleges in your state only.
Remember that you don’t necessarily have to choose between a prepaid 529 or a savings plan. It’s important to understand the pros and cons of both types of plans to work out which is right for you, or if you could benefit from saving with both.
Frequently Asked Questions (FAQs)
Is prepaid tuition tax deductible?
Contributions to prepaid tuition plans are state-tax-free. However, your payments or contributions won’t be tax-deductible for your federal income tax.
Do 529 prepaid tuition plans have investment risk?
No, 529 prepaid tuition plans are not tied to the stock market, and so don’t carry investment risk. These kinds of plans are state-sponsored, so the funds are guaranteed as long as the state’s funding is secure.
Does California have a 529 prepaid tuition plan?
No – California is not one of the states currently accepting new applicants into their prepaid tuition plan.
Is a prepaid 529 plan transferrable?
Yes, like other kinds of 529 plans, you can transfer your prepaid tuition plan to another child in your family. This can be useful if your child chooses to attend college in another state, or not at all.