What is a '529 Prepaid Tuition Plan'

A 529 prepaid tuition plan is a way to pay the cost of tomorrow’s college-inflated tuition prices at current costs.

Unlike using a 529 as a savings plan where you invest money in different asset classes (stocks, bonds, mutual funds), prepaid tuition plans allow you to pay for a certain number of semesters (or contracts) that can be redeemed in the future. These program administrators then pool the money and make long-range investments so that the earnings meet or exceed college tuition increases. When a child is ready to go to college, the plan transfers funds to cover the tuition directly to the institution.

BREAKING DOWN '529 Prepaid Tuition Plan'

Parents, relatives and friends are all allowed to contribute to the child's 529 prepaid tuition plan, which can be especially helpful to grandparents who want to give money to their grandchildren in a tax friendly way.

With tuition increasing at faster paces than expected, many of these plans discovered that they couldn’t invest successfully enough to keep up with rising costs. That put both sides of the equation in binds. Upon realizing the plan would be underfunded, the administrators usually refunded their money back with nominal interest, and parents were left trying to figure out how to pay for tuition.

Keep in mind only tuition is covered in prepaid plans, unlike 529 savings plans that can be used for some room and board, books, equipment and fees.

Another disadvantage is that these plans require that students attend an in-state public school, so if they want to venture far from home you’ll be hit with out-of-state tuition rates.

If the child who is the account beneficiary dies, decides not to attend college, decides to attend college in a state other than the one in which the plan was established or decides to attend a private college, prepaid tuition plans do offer options. Credits may be transferred to another child, contributions may be withdrawn, or the in-state value of the prepaid credits may be transferred to an out-of-state or private institution.

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