For families on that long road to college savings, prepaid tuition plans can be a good investment, allowing account holders to essentially pay tuition of the future at the rates of today. But, they've become a rare commodity. Eighteen states used to offer the plans; that number has dwindled to just 11 states. Find out what prepaid tuition plans are, where you can still find them and if they're the right education investment option for you.
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What's a Prepaid Tuition Plan?
Prepaid tuition plans allow investors to purchase tuition for a student at current rates, even if he or she will not attend college for several years. Timing and age is a crucial factor with prepaid tuition plans, as most require plan participation for at least three years before funds can be used, and that the beneficiary be 15 years old or younger at the time of account inception.
The prepaid tuition program itself pays future college tuition at any of the state's eligible colleges or universities - or it offers cost-weighted payment to private or out-of-state institutions. The program does this by pooling and investing the plan's funds, allowing it to make enough money to exceed the pace of rising state college tuition. Essentially, you're loaning your money to the state's plan in return for the locked-in tuition rate.Tuition can be purchased in monthly installments or a lump-sum. (Determining monthly contributions to college funds, retirement plans or savings is easy with this calculation, read Time Value Of Money: Determining Your Future Worth.)
It is important to note, however, that prepaid plans are often only of value if you are absolutely certain your child will attend an in-state school. While most of the plans do allow funds to be used for out-of-state college tuition, there is often an accompanying penalty, either in the form of a fee or weighted payment based on your state's tuition rates.
The other popular college savings vehicle, called a 529 savings or investment plan, allows participants to save money for K-12 education costs or college, on behalf of a designated beneficiary, who can be a child or adult learner. Contributions to the account and any investment earnings it generates can be used to pay for the beneficiary's qualified education expenses, including books and related education costs outside of tuition. If the beneficiary's education plans change, investors can change the beneficiary, or withdraw the funds in the account for a non-qualified distribution - meaning, the funds are not used for higher education expenses. In that scenario, said earnings, but not contributions, are subject to state and federal tax plus a 10% federal tax penalty. (The Independent 529 plan offers a unique investment for those wanting to send their kids to the best colleges in the U.S., read A 529 Plan Fit For An Ivy League Education.)
Where Are the Prepaid Tuition Plans?
The states that still offer prepaid tuition include Virginia, Maryland, Massachusetts, Mississippi, Florida and Washington. These states guarantee their prepaid plans. Michigan, Nevada, Illinois, Pennsylvania and Texas also offer prepaid tuition plans, but without any guarantee. (Meaning, they can terminate or change the plans at any time without obligation to investors).
The Florida Prepaid College Plan earnings are exempt from federal and Florida state income tax. The child and/or his/her parents must be Florida residents when the plan is initially established, but accounts may be opened by anyone.
The Maryland Prepaid College Trust is the state's section 529 prepaid tuition plan. Benefits under it are exempt from federal and Maryland state income tax.
Massachusetts U. Plan allows parents of any state to lock in tuition at today's rates at more than 80 participating Massachusetts public and private colleges and universities.
The Michigan Education Trust (MET) (Michigan) was the first state prepaid tuition plan and pays for up to four years of tuition expenses.
The Mississippi Prepaid Affordable College Tuition Program benefits are transferable to other family members. Earnings are exempt from state income tax and contributions are deductible for Mississippi income tax purposes.
The TAP 529 Guaranteed Savings Plan credits can also be used, without penalty, at any private college in Pennsylvania or any other accredited college, university, trade or trade school in the United States.
The Texas Guaranteed Tuition Plan (formerly the Texas Tomorrow Fund) is closed to new enrollment.
The Virginia Prepaid Education Program (VPEP) requires that students be in the ninth grade or younger and the account purchaser or beneficiary must be a Virginia resident.
The Guaranteed Education Tuition Program (GET) requires that the beneficiary or account owner be a Washington resident at the time of enrollment. Qualified withdrawals are exempt from federal income tax. Washington has no state income tax.
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The Bottom Line
While prepaid tuition plans are becoming harder to come by, they are still out there, if you know where to look. Consider these viable investment options when seeking the best financial options for looming college expenses that may soon lie ahead. (For more, see 6 Sources Of Student Money You May Have Missed.)