What is a prepaid tuition plan? According to Investopedia, “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 [are] 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.”
Why are these plans so beneficial? For many of you reading this blog today, the prepaid tuition “boat” may have already sailed. But if that’s not the case, you might ask what are some of the advantages to using your state’s prepaid tuition plan?
- Potential to pay less out of pocket for college tuition and fees in the future
- The state bears the risk of significant increases in tuition expense rather than the investor
- Funds saved in prepaid tuition plans are exempt from federal income tax and state income tax (if applicable) as long as the funds are used for qualified education expenses
- There is no market risk; in other words, you can’t lose your prepaid tuition money in a stock market crash
Which states offer these plans? Currently there are 10 states that provide prepaid tuition plans, down from 18 not too long ago. The downward trend for states offering prepaid tuition plans will likely continue. In December of last year, for example, the Commonwealth of Virginia delayed enrollment for its Prepaid Tuition 529 due to funding concerns and are still awaiting approval from the General Assembly to re-open new enrollments. Here is the line-up of states offering prepaid tuition plans at the present time:
Please note that not all states guarantee their prepaid plans. Michigan, Nevada, Illinois, Pennsylvania and Texas do not provide a guarantee and thus terminate or change their plans at any time.
Why are these plans disappearing? The reality is that tuition is rising at a rate much higher than other sectors of the economy, and many states simply can’t afford to take on the risk. As shown by the chart below, College Tuition & Fees are increasing at a rate of 156% since 2000, which is approximately three times higher than the Consumer Price Index (CPI) over that same timeframe.
So why wouldn’t someone want to lock in the future costs of tuition if they live in one of the 10 states offering a prepaid tuition plan?
- These plans can only be used for in-state public colleges/universities (i.e. not helpful if your son or daughter goes to a private or out of state college/university)
- The plans cover just the cost of tuition and fees, which is often only half of the total cost of attendance
- If your children decide to not go to college and you decide to use the funds for something other than qualified education expenses, the earnings (not the contributions) are subject to state and federal tax in addition to a 10% federal tax penalty.
Can you transfer these plans to another child? Most states will allow you to transfer the prepaid tuition plan credits between members of the same household, and therefore there is less risk with this kind of plan if you have more than one child that is planning to attend an in state public college. For families with only one child or where there isn’t as much certainty as to where the student will want to study, it is probably a safer strategy to invest in a “Savings Variety” 529 plan which can be used for any qualified education expense in the world as long as the school is accredited.
I hope this blog was informative. If you have any questions regarding prepaid tuition plans or the broader strategies of college funding, please feel free to reach out to me at 703-394-7176 or email@example.com.
James L. Hicks, CFP®