Prepaid college savings plans: Here's what you need to know

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Updated 2016-11-17

Most of what we hear and read about 529 plans is focused on the more popular "savings" plans, but for some families there's another effective way to prepare for college costs. As the name implies, prepaid tuition plans allow you to pre-pay future college costs today. There are currently 18 state-sponsored and one institution-sponsored prepaid plan (Private College 529 Plan), but only 11 are currently accepting new applicants, and nine of these have residency requirements.

Of the 11 available plans, nine are "contract" plans, which allow you to pay for a certain number of semesters of college tuition, and two are "unit" plans, which let you buy fractional units that are redeemable in the future based on average tuition rates at a target group of schools, typically one percent of one year of tuition. In other words, contract plans work like a futures contract and unit plans operate like a tuition index fund.

When deciding on a college savings plan, you generally don't have to choose between a prepaid plan or savings plan. Some families may benefit from saving with both types. If you're thinking about enrolling in a prepaid plan, here are a few things to consider.

RELATED: Busting the top 7 myths about prepaid plans

What's good:

Prepaid 529 plans offer many of the same benefits as 529 savings 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 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 $14,000 per year per individual will qualify for the annual exclusion (in 2016). What's more, if you elect to treat your gift as if it were made over a five-year period, as much as $70,000 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 an UGMA/UTMA account his aid package could be reduced by as much as $2,000.

RELATED: Here's how much you can contribute to a 529 plan in 2016

You can lock in future tuition costs today. Rising tuition prices aren't exactly the latest news. The College Board recently published their Trends in College Pricing 2016 report, which shows that once again, the costs of attending colleges and universities has gone up. In fact, since last year, tuition at public two-year, public four-year (in-state) and private four-year has risen 2.3%, 2.4% and 3.6%, respectively. Prepaid plans can help hedge against college inflation by letting savers lock in future tuition at current rates.

You won't lose your money if your child attends another school. While prepaid plans are typically designed to pay for tuition at a certain school or schools, 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.

RELATED: 6 winning strategies to cutting the cost of college

What's not so good:

Prepaid plans don't cover as many costs. 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.

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).

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 began its enrollment period October 15, 2015 and will be running through February 28, 2017.

Where to find prepaid tuition plans

These plans will be accepting new applications during their specified enrollment periods:

Virginia529 prePAID
Florida Prepaid College Plan
Washington Guaranteed Education Tuition
College Savings Plans of Maryland – Prepaid College Trust
Massachusetts U.Plan
Michigan Education Trust
Mississippi Prepaid Affordable College Tuition (MPACT) Program
Nevada Prepaid Tuition Program
Pennsylvania 529 Guaranteed Savings Plan
Texas Tuition Promise Fund
Private College 529