Prepaid tuition plans allow families to buy all or part of a public in-state education at today’s prices. The value of the investment is guaranteed to increase at a rate that coincides with the cost of college tuition. State governments operate the plans, and there are currently 19 states that offer this type of 529 Plan. The main benefit to a prepaid tuition plan is that it allows individuals to lock in tuition at the current rate.
If the student attends an in-state public college or university, the plan pays the tuition and required fees. If the student decides to attend a private or out-of-state college or university, the plans usually pay the average of an in-state public college tuition. The parents or student are responsible for any difference.
Money in prepaid tuition plans is controlled by the account owner not the child. However, the assets are not considered part of the account owner’s estate. Prepaid tuition plans also offer the same tax status as Section 529 College Savings Plans.
If the child dies or chooses not go to college, the funds can be transferred to another family member.
If the child moves out of state but attends a participating school, the family can still use the plan; however, the family may be held responsible for the difference between out-of-state tuition and in-state tuition depending on the plan. There are some plans that will treat the student as in-state and cover 100% of the cost.
There are two types of prepaid tuition plans:
- Prepaid Unit
- Sells units that represent a fixed percentage of tuition with one unit typically corresponding to 1% of the year’s tuition.
- Everyone pays the same price for the units and the price of a unit increases each year.
- Unlimited units can be purchased each year.
- Contracts
- Sells contracts where a specified number of years of tuition will be purchased.
The purchase price depends on the age of the child and on the type of payment (lump-sum or installment). - The contract usually offers lower prices for younger children, as the state has more time for the assets to grow.
- Sells contracts where a specified number of years of tuition will be purchased.
Advantages
- Locks in tuition at today’s rates;
- Most prepaid tuition plans are guaranteed by the full faith and credit of the state;
- Account owner controls assets, and can change beneficiary;
- Assets are not considered part of the account owner’s estate;
- No income phaseout on contributions or withdrawals;
- Same tax advantages as Section 529 Savings Plans—tax deferred growth and tax free withdrawals;
- Usually offer better rate of return than bank savings accounts or CDs;
- No risk to principle;
- Tend to act as a hedge against economic downturns. In times of recession, state governments tend to reduce support for public education institutions, potentially causing an increase in tuition rates. When other investments are typically dropping because of a declining stock market, prepaid tuition plans will tend to increase, and
- Anyone can contribute to a prepaid tuition plan (grandparents, friends, etc.).
Disadvantages
- Limited to state residents. Most plans require the beneficiary or the account owner to be a state resident when the account is established;
- Return on investment may not meet the full cost of private or out-of-state colleges;
- Enrollment period may be limited;
- Pulling out of prepaid tuition plans can result in high penalties, which include cancellation costs and/or loss of interest;
- Many states’ plans are limited to tuition and fees and do not include room and board. The family or student will have to save for these in another account or pay for these out of pocket;
- Maximum contributions are lower than 529 College Savings Plans—Contribution limits to prepaid tuition plans are based on the current cost of four years of in-state tuition at public colleges;
- Prepaid tuition plans are very conservative investments, and
- Many prepaid tuition plans include a 10-year time limit from the expected college entrance date, or high school graduation, where the student must use the assets in the account.
Bottom Line
If an investor has a long time to save for higher education costs (10 or more years), we feel that more productive investments that would cover room and board could be made elsewhere. Still,Henssler Financial feels you should investigate Education Savings Accounts, Section 529 Savings Plans and prepaid tuition plans to determine what works best for you. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
