PREPAID TUITION plans are a type of 529 plan. But unlike a 529 college savings plan, where you aim to earn healthy investment gains by picking from among a menu of mutual funds, a prepaid tuition plan is designed to let you lock in future tuition costs at today’s price. In effect, your rate of return should equal the percentage by which tuition costs increase between now and when your kid heads off to college.
In practice, you may earn less than the rate of tuition inflation, because many prepaid plans charge a premium price for these future tuition credits. Moreover, the credits can only be used at certain colleges, so you should read the small print to see what happens if your child opts to go elsewhere.
In the past, prepaid plans in some states have struggled financially and been closed at least temporarily to new investors. While some state prepaid plans are backed by the full faith and credit of the state, other plans don’t have that sort of backing, which means payouts could be scaled back if the plan doesn’t earn a high enough return when investing participants’ money.
As with a 529 college savings plan, parent-controlled prepaid tuition plans are treated as a parental asset for financial aid purposes and the gains are tax-free at the federal level as long as the money is used for qualified education expenses. You may also be eligible for special state tax breaks. To research plans, head to SavingforCollege.com.
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