Saving for college can be daunting, but with the help of prepaid 529 plans, families can take advantage of attractive tax benefits and secure their child’s future education expenses. In this blog post, we’ll explore the details of prepaid 529 plans, including how they work, their tax advantages, and how they differ from traditional 529 plans. We’ll also delve into which states have approved prepaid 529 plans and what happens if you move out of a state in which the plan is approved.
Understanding Prepaid 529 Plans
Prepaid 529 plans are a type of college savings plan designed to help parents or guardians lock in future tuition rates at today’s prices. These plans provide peace of mind, as they protect against the rising costs of education, offering an excellent opportunity to safeguard your child’s educational future. The cost of education was rising fast enough in times of low inflation, but in an inflationary environment it is possible that we see the cost of higher education accelerate even further.
Prepaid 529 Plans vs. Traditional 529 Plans
Prepaid 529 plans work differently from traditional 529 plans. Instead of investing contributions in a diversified portfolio of funds and subjecting them to market fluctuations, prepaid plans allow account holders to purchase credits or units representing a fixed percentage of future tuition costs. These credits can then be used to cover tuition and, in some cases, other qualified higher education expenses at participating colleges and universities. In short, traditional plans may offer potentially higher returns, but they don’t guarantee a fixed amount of future tuition costs.
Another major difference is that a prepaid plan limits your educational options, which you (or your children) may or may not be comfortable with. If you purchase a prepaid 529 plan and then move out of the state where the plan is approved, you generally don’t lose the benefits of the plan. Each state’s plan outlines the specific terms and conditions regarding residency requirements and some plans may allow you to maintain the benefits regardless of your new state of residence, while others may have restrictions. It’s essential to review your state’s plan details to understand the how plan benefits may be affected.
While traditional 529 plans cover a wide range of education-related expenses, prepaid plans tend to stick narrowly to tuition and fees. In many cases, a hybrid approach of supplementing a prepaid plan with traditional 529 plan contributions might work best to cover all expenses associated with college.
Tax Advantages of Prepaid 529 Plans
One of the most significant benefits of prepaid 529 plans lies in the tax advantages they offer:
- Tax-Deferred Growth: Just like traditional 529 plans, prepaid plans grow tax-deferred, meaning you won’t pay taxes on the earnings as long as the funds remain in the account.
- Tax-Free Withdrawals: When funds are used for qualified higher education expenses, withdrawals are tax-free, making these plans a tax-efficient way to save for education.
- Potential State Tax Deductions: Many states offer tax deductions or credits on contributions made to prepaid 529 plans. It’s essential to check the specific tax benefits offered by your state.
States Offering Prepaid 529 Plans
While at one time 22 states offered prepaid 529 plans, as of this writing only 8 states offer plans open to new enrollment: Florida, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas and Washington.
Prepaid 529 plans can present an attractive option for parents seeking to secure their child’s college education at today’s prices. With tax advantages and the assurance of locking in future tuition rates, these plans offer a valuable means of preparing for your child’s academic journey. Not all plans are created equally, however, so it’s crucial to research and compare different prepaid plans, understand their terms and conditions, and assess how a potential move or going out of state could affect the plan’s benefits. As the number of states offering prepaid plans dwindle, now might be a good time to look into whether this might be a good planning move for your family.
Neither MML Investors Services nor any of its subsidiaries, employees or agents are authorized to give legal or tax advice. Consult your own personal attorney, legal or tax counsel for advice on specific legal and tax matters.