Prepaid College Tuition Plans: Those That Still Exist Offer Great Benefits

The cost of a four-year public college education increased by 24% in the last 10 years and 102% over the past two decades, according to data from the Manhattan Institute.

With the ever-rising cost of college tuition, wouldn’t it be great to lock in future tuition costs at today’s rate?

You can with a prepaid college tuition plan. However, these plans have limitations, so they aren’t always the best strategy to save for college. Here’s what you need to know about prepaid college tuition plans.

What is a prepaid college tuition plan?

A prepaid college tuition plan is a type of 529 plan that lets you prepay future college expenses at a predetermined rate. How does this work?

In general, a saver (e.g. parent or grandparent) can purchase credits or a certain number of years of tuition by making lump-sum or installment payments to the prepaid tuition plan. When the beneficiary begins college, the plan funds are transferred directly to the participating university.

Prepaid tuition plans are usually sponsored by a state agency. Therefore, account holders and beneficiaries can have relatively high confidence they’ll have access to the predetermined rate for tuition and fees many years into the future. Most (not all) state-sponsored prepaid plans guarantee the plan’s funds will keep pace with tuition and have safety measures in place (e.g. appropriated funds) for added assurance.

Alternatively, the Private College 529 Plan consists of hundreds of participating private institutions, including historically black colleges, research universities and religiously affiliated schools.

Advantages of using prepaid college tuition plans

There are many benefits to using a 529 prepaid tuition plan, but the biggest advantage is the ability to secure current tuition rates. This guards against tuition inflation and can make college significantly less expensive in the future.

Student Loan Planner® Founder, Travis Hornsby, was able to take advantage of a prepaid college tuition plan thanks to his parents’ forethought. Weighing his own experience and current higher education conditions, he said:

“I was really lucky that my parents purchased the Florida prepaid tuition plan for my college. It worked out because I ended up staying in-state. However, you can't buy prepaid plans at yesterday's prices. State governments have realized that the cost of these plans was higher than anticipated, so they aren't as good of a deal as they used to be.”

Here are some additional perks to consider when exploring prepaid college tuition plans:

• Tax benefits. Prepaid tuition plans receive federal tax advantages, including tax-free growth and withdrawals when spent on qualified education expenses. Additionally, some states allow for tax-deductible contributions.
• High (or no) contribution limit. Most plans have high contribution limits or don’t have a limit at all. Unlike other college savings tools (e.g. Coverdell education savings account), you don’t have to worry about capping your contributions each year.
• Parent asset. 529 plans are treated favorably as a parental asset when completing the Free Application for Federal Student Aid (FAFSA).

As an added benefit, funds can usually be transferred or refunded if your child chooses a different path than you originally planned for. But you might have to cover the difference in tuition, depending on where your child ends up.

The downside of using a prepaid college tuition plan

Although prepaid tuition plans can greatly benefit a student later down the road, they have some potential disadvantages to be aware of.

By choosing a 529 prepaid tuition plan, you might limit your child’s future school options or add pressure for them to attend an in-state college.

Additionally, prepaid plans typically only cover the cost of tuition and fees. In comparison, funds from a 529 savings plan can be used for a number of college costs, including room and board, technology equipment (e.g. laptop and printer), and other qualified higher education expenses.

Residency requirement

Even if you decide you want to invest in a prepaid college tuition plan, you might have limited options. Most states don’t offer a prepaid tuition plan anymore, and the ones that do typically have residency requirements and specific enrollment periods.

For example, the Texas Tuition Promise Fund is limited to Texas residents with an enrollment window between September 1 and February 28 (newborns can be enrolled through July 31).

However, the Private College 529 Plan provides open enrollment throughout the year and is open to savers across the country.

Prepaid tuition plans are at a decline

As tuition has skyrocketed, prepaid college tuition plans have become far and few between. Only a handful of states offer this type of 529 plan and some are no longer accepting new applications. Why is this downward trend likely to continue?

The cost of tuition is rising at a much higher rate than other sectors of the economy. Similar to the pension crisis, states can no longer afford the risk of an unfunded liability. Additionally, many families are willing to use a 529 savings plan as an alternative due to greater flexibility.

Current states accepting new enrollment for their prepaid college tuition plan include:

• Florida
• Maryland
• Massachusetts
• Michigan
• Mississippi
• Nevada
• Pennsylvania
• Texas
• Washington

Note that some states still honor their prepaid tuition plan (by appropriating funds) but have halted opportunities for new savers.

Should you use a prepaid tuition plan?

Prepaid tuition plans come with limitations, but they can provide great benefits for the account holder and beneficiary.

Here are some scenarios where a prepaid college tuition plan might make the most sense for your family:

1. You’re confident your child will attend a specific school or a public college in your state.
2. You’d prefer to have a guaranteed tuition rate, rather than taking your chances with the stock market.
3. You’re not interested in managing investments for your college savings.

If you live in one of the few states that still offer a prepaid college tuition plan to new applicants, it can be a great way to jumpstart your child’s education savings.

However, there are many alternative savings tools that might be a better fit. For example, a 529 college savings plan is much more flexible when it comes to choosing a college and paying for education expenses. You’ll also have access to more plans since you aren’t limited to choosing your own state’s plan.

There’s no one-size-fits-all when saving for college, so it’s important to explore your options and decide on the best route for your family’s financial situation.