Prepaid Tuition Plans versus College Savings Plans

Prepaid tuition plans and college savings plans are the two specific types of 529 plans. Every state in the US offers at least one of two types of 529 plans. Independent groups composed of universities and private colleges also often sponsor their own 529 plans.

Regardless of specific type, 529 plans share one common attribute. Their underlying investments often become more conservative as the beneficiary comes closer to college age.

Prepaid Tuition Plans

Prepaid tuition plans, as the name suggests, involve the purchase of tuition credits from participating colleges and universities at the current going rate for use by a beneficiary in the future.

Sometimes, prepaid tuition plans include purchase of credits for use in paying mandatory college/university charges as well as room and board expenses. In some prepaid tuition plans, excess tuition credits may be used to pay for such additional expenses.

Prepaid tuition plans essentially lock in tuition prices to today's rates. As such, the performance of this investment is based upon tuition inflation. If tuition fees rise, the investor saves money because his plan's beneficiary can go to college using tuition credits bought when tuition fees were lower.

Many prepaid tuition plans base payment amounts of investors on the beneficiary's number of college tuition years as well as the beneficiary's age. As with most other pre-need vehicles, it is advisable to start on a prepaid tuition plan early as monthly or lump sum payments tend to increase with the age of the intended beneficiary. Moreover, most of these prepaid tuition plans have a grade or an age limit for beneficiaries as well as a limited enrollment period.

Most prepaid tuition plans are sponsored by state governments or state government agencies. State-sponsored prepaid tuition plans are secure as they are backed or guaranteed by the state. Of course, state-sponsored prepaid tuition plans are usually restricted to state residents.

College Savings Plan

College savings plan offer investors greater flexibility and greater savings potential than prepaid tuition plans. College savings plans (or university savings plans) have higher contribution limits than prepaid tuition plans (especially state-sponsored prepaid tuition plans). Furthermore, they often have fewer restrictions on qualified withdrawals. In the case of college savings plans, distributions may be used to cover not only tuition fees, mandatory fees and room/board expenses but also the purchase of a computer (if required) and textbooks.

College savings plan also do not impose age limits on beneficiaries. The beneficiary of a collage savings plan may be a child or an adult. Enrollment is also open year-round, unlike prepaid tuition plans that have set enrollment periods.

College-savings plans are most often not sponsored by state governments or state government agencies. Thus, a college savings plan usually does not come with a state restriction and the beneficiary can use it to fund his college education in any state. Of course, this also implies the lack of state-backing.

College savings plans generally do not lock in tuition costs. This can be an advantage or a disadvantage depending on tuition fee inflation.

College savings plans are also market-performance dependent. They are tied to underlying investments, and earnings depend on the growth of such investments. Investment options include money market funds, bond mutual funds, stock mutual funds, and age-based portfolios (portfolios that shift towards more conservative investments as the beneficiary nears college age). Thus, there's a risk that investors can lose or may find no growth in their investment.

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