Prepaid tuition and college savings plans are the two types of 529 plans, plans with tax advantages created to help families save to pay for college. Each state in the United States sponsors at least one type of 529 plan, and some offer both options. Both plans require that an account name only a single beneficiary.
Owners of prepaid tuition plans purchase credits or shares of tuition and mandatory fees years ahead of time. The prepaid tuition plan allows plan owners to lock in tuition rates and fee amounts at participating schools at the time of their purchase, protecting them against rising college costs. Payments are made either in lump sums or installments. In contrast, college savings plans are investment vehicles. Account owners and others contribute to the account, and the money is invested in an investment fund or funds, such as a mutual fund. The funds grow tax-free over the years, so that the money can be withdrawn for qualified educational expenses without incurring any tax charge.
A college savings plan carries a greater risk than prepaid tuition plans. The value of a college savings plan depends largely on the performance of the funds in which money has been invested. Plan owners must accept that their investment could provide disappointing returns that prove insufficient to account for expenses that they hoped to cover. However, prepaid tuition plans typically are guaranteed by the states that offer them, protecting against market declines, according to the Securities and Exchange Commission.
Qualified Education Expenses
The funds from college savings plans can be used on a broader array of education-related expenses than prepaid tuition plans. College savings plans can be used to cover costs for tuition, room and board, mandatory fees and various types of essential equipment, such as textbooks and computers. Prepaid tuition plans, meanwhile, only can be utilized to fund tuition and mandatory fees. However, some prepaid plans also include a supplementary plan to buy an option for room and board costs or to opt to apply any unneeded purchased credits to funding certain other education expenses.
College savings plans don't place restrictions on who participates either as a beneficiary or plan owner, except participants must be U.S. citizens. Prepaid tuition plans have more barriers to participate, often requiring that either the owner or beneficiary is a resident of the state offering the plan. Prepaid plans also restrict the window when someone can purchase a plan, offering limited enrollment periods and requiring that beneficiaries meet age or grade limits. College savings plans typically are available for use at colleges and other educational institutions across the country, while prepaid tuition plans can only be used at participating schools. For instance, a prepaid tuition plan might be designed for use solely at public colleges in the sponsoring state.