Pros and Cons of Prepaid Tuition Plans

Prepaid tuition plans, a type of 529 plan, offer families the opportunity to pay for their children's future college tuition at today's rates. However, these plans come with both advantages and disadvantages. This article explores the pros and cons of prepaid tuition plans to help families make informed decisions about their college savings strategy.



Pros of Prepaid Tuition Plans

1. Hedging against tuition inflation: Prepaid tuition plans allow families to lock in today's tuition rates, protecting them from future tuition increases. According to the College Board, the average published tuition and fees for in-state students at public four-year institutions increased by 21% between 2008 and 2018. By prepaying tuition, families can avoid a significant portion of this inflation.
2. High contribution limits: Prepaid tuition plans often have high contribution limits, allowing families to save a substantial amount for their children's education. For example, the Maryland 529 Prepaid College Trust has a maximum contribution limit of $400,000 per beneficiary.
3. Tax advantages: Many states offer tax benefits for contributions to prepaid tuition plans, such as tax deductions or credits. Additionally, earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses.
4. Flexibility in payment: Prepaid tuition plans often offer flexible payment options, such as lump-sum payments or installment plans, making it easier for families to save for their children's education.

Cons of Prepaid Tuition Plans

1. Limited use: Prepaid tuition plans can only be used for tuition and mandatory fees, unlike college savings plans that can be used for a broader range of qualified education expenses, such as room and board, books, and supplies.
2. State-specific: Prepaid tuition plans are typically state-specific, meaning the beneficiary must attend an in-state college or university to use the funds. This limitation may not be an issue if the beneficiary plans to attend an in-state school, but it could be a disadvantage if they choose to attend an out-of-state or private institution.
3. Potential penalties: If the funds in a prepaid tuition plan are used for non-qualified expenses, the earnings may be subject to taxes and a 10% penalty. This is the same as with other 529 plans.
4. Risks associated with state plans: Prepaid tuition plans are typically state-sponsored, and there is a risk that the state's plan may go bankrupt or be mismanaged, putting the parent's investment at risk. For instance, in 2017, the Illinois State Treasurer's Office announced that the Illinois Prepaid Tuition Program would be unable to cover the full cost of tuition for students who enrolled in the program before 2018 due to financial mismanagement.

In conclusion, prepaid tuition plans offer families the opportunity to hedge against tuition inflation and save for their children's education with high contribution limits and tax advantages. However, they also come with limitations, such as limited use and state-specific restrictions, as well as potential risks associated with state-sponsored plans. Families should carefully consider these pros and cons when deciding whether a prepaid tuition plan is the right choice for their college savings strategy.