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“Pre-paid” college usually takes the form of pre-paid 529 plans, which are tax-advantaged plans that enable families to lock-in the cost of college at the time that they purchase the plan. Considering that every year the cost of college rises about 2 percent to 3 percent, pre-paid college can be a worthwhile option to consider.
Disadvantages to traditional pre-paid college plans include a lack of flexibility in the way the money can be used.
Most 529 prepaid college plans are administered by individual states, and they differ somewhat from state-to-state. Although you can often transfer pre-paid tuition credits from state-to-state, fees do apply, and can add up. For this reason, the biggest saving is when your child attends college in the state where the plan was purchased and administered.
Most states have residency requirements for investing in their 529 pre-paid college plans, requiring that the person who invests in the plan must live in the state where purchased. If, for example, you and your child live in New York and your parents live in Massachusetts, your parents can pay into a Massachusetts-run pre-paid college plan on behalf of your child. This scenario makes sense if your child plans to attend college in Massachusetts. However, if your child later decides to attend college outside of Massachusetts, he or she may incur fees for transferring pre-paid college credit from the Massachusetts-run plan to a plan in a different state.
One reason why 529 pre-paid college plans can be a good investment for some people is because of the tax benefits. Although there is no upfront tax advantage in that money invested in pre-paid college plans is not tax deductible, money can be withdrawn from 529 pre-paid college plans tax-free as long as the money is used for tuition expenses. This can be both an advantage and disadvantage, depending on the circumstance. Unlike private save-for-college plans that allow the money to be used for anything, money from pre-paid college plans must be used to pay tuition costs. Considering that tuition costs are typically one-fifth of the total cost of college, a save-for-college plan that lacks the flexibility for covering all of the costs of college can leave a lot left to pay.
This assumes that the beneficiary of a pre-paid college plan ends up going to college, because if the money is not used for college tuition, it can incur significant taxes and fees upon withdrawal. The good news, however, is that in most states, pre-paid college plans can be transferred to a member of the beneficiary’s family.
Whether pre-paid college plans are worth it depends on your individual situation. It’s best to take a broad approach to saving for college by putting money aside in a way that works best for your budget and your child’s future – no matter what it holds.
Source: The College Board
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