- There are two types of 529 plans – prepaid tuition plan and college savings plan.
- Each state designs and administers its own 529 plans.
- 529 prepaid tuition plans lock in tuition at participating schools and enforce more restrictions for participation than 529 college savings plans.
While 529 plans are authorized by the federal tax code, they are designed and administered separately in each state. Some states have both a prepaid college tuition option and a college savings option, while other states only administer one type of plan or the other. Understanding the difference between the two plans is critical to your decision-making. After all, you want to be sure that funds are available when your student is ready for higher education.
Pros and Cons of a 529 Prepaid Tuition Plan
The cost of college is rising quicker than inflation, and part of the challenge of saving for education expenses is trying to figure out how much your student will need. The most popular benefit of prepaid plans is that tuition is locked in at participating colleges and universities. If you have a strong family history at a certain school, or a handful of your student’s top choices are covered by the program, prepaid tuition can save you quite a bit when you compare today’s prices with estimated prices of the year of enrollment.
The downside to this is a lack of flexibility in the amount you set aside. The prepaid tuition programs typically require regular payments that are calculated by dividing the cost of tuition by a number of months or years based on the beneficiary’s age at the time the plan is purchased. Because of the plan’s payment design, there is often a requirement that the beneficiary be under a certain age or grade in order to participate. Note that your prepaid plan typically only covers tuition and fees, not room and board. Most state-administered prepaid tuition plans require that you be a resident, so if your state doesn’t offer this option, you may have some difficulty selecting a prepaid program.
Choosing Between 529 Prepaid Tuition and 529 College Savings Plan
If any of these 529 prepaid plan rules are deal-breakers, you may wish to participate in a 529 college savings plans. This table compares the features of both:
|Plan features||529 Prepaid Tuition Plan||529 College Savings Plan|
|Guarantee on tuition||Guarantees today’s tuition rates at participating colleges and universities||No lock on tuition rates|
|Qualified expenses||Plan proceeds cover tuition and mandatory fees||Savings can be used for all qualified educational expenses, including tuition, room and board, books, computers, software or internet access , and mandatory fees|
|Contribution method||Plans are set up with installment payments, with the total amount divided by the age of the beneficiary||Contribution amount is up to account holder and maximum limits range from approximately $200,000 to $400,000 depending upon the state|
|Guaranteed returns||Most plans are guaranteed by the state||Savings are not guaranteed, are subject to standard investment risk and can lose value|
|Beneficiary age requirement||Many plans limit beneficiaries’ age or grade to future college students||No age limit on eligibility|
|Residency requirement||Most plans have a state residency requirement||Typically no residency requirement*|
|Enrollment period||Some plans have a set enrollment period||Enrollment is open year round|
* The Louisiana 529 College Savings Plan is only available to residents of the state.
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This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.
For information on any 529 college savings plan contact the plan provider for details on the investment objectives, risks, charges, expenses, and other important information included in the Plan Description and Participation Agreement; read and consider it carefully before investing.
Please Note: Before investing in any 529 plan, you should consider whether you or the beneficiary’s home state offers a 529 plan that provides its taxpayers with favorable state tax and other benefits that are only available through investment in the home state’s 529 plan. You also should consult your financial, tax, or other advisor to learn more about how state-based benefits (or any limitations) would apply to your specific circumstances. You also may wish to contact directly your home state’s 529 plan(s), or any other 529 plan, to learn more about those plans’ features, benefits and limitations. Keep in mind that state-based benefits should be one of many appropriately weighted factors to be considered when making an investment decision.
Earnings on nonqualified withdrawals are subject to federal income tax and may be subject to a 10 percent federal tax penalty, as well as state and local income taxes. The availability of tax and other benefits may be contingent on meeting other requirements.