The difference between prepaid tuition plans & college savings plans

Last updated: January 1

As you begin to think about saving for your child's college education, it's important to understand the options available to you. You may have heard of prepaid tuition plans and college savings plans. Here's a look at how each option works.

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Prepaid tuition vs. college savings plans

Prepaid tuition plans and college savings plans are the two types of 529 plans (also called qualified tuition plans), according to the Internal Revenue Service (IRS). Each type of plan offers tax advantages intended to help save for college expenses. Prepaid tuition plans let you purchase college credits or units at today's prices to be used in the future. College savings plans let you invest contributions that can be withdrawn later to help pay for qualified tuition expenses.

At least one type of 529 plan is offered in all 50 states, as well as the District of Columbia.

Prepaid tuition plans

A prepaid tuition plan allows you to purchase college units or credits, and in some cases room and board, for future enrollment at a college or university that participates in the plan. According to the Financial Industry Regulatory Authority (FINRA), most prepaid tuition plans allow you to prepay tuition at participating colleges at today's price. With the cost of tuition rising each year, this can provide big savings for your future scholar. Best of all, the U.S. Securities and Exchange Commission (SEC) says many prepaid tuition plans are backed by the state.

Keep in mind that many plans require you or your child ( "the beneficiary ") to be a resident of the state that sponsors the plan. Additionally, prepaid tuition plans have a limited enrollment period each year.

Upon enrollment, your payment plan will be determined based on the current age of your child and the number of years of tuition you buy.

College savings plans

A college savings plan allows you to open an account where your contributions will be invested in bond mutual funds, stock mutual funds or money market funds, according to the SEC. If this sounds like a risky choice, note that most plans choose more conservative investments as the beneficiary approaches college age. However, college savings plans are not state guaranteed or federally insured, according to the SEC.

College savings plans typically cover any "qualified higher education expenses. " These expenses often include tuition, room and board, mandatory fees and -- unlike a prepaid tuition plan -- required materials such as books and computers, according to the SEC.

College savings plans have no age limits, and you can enroll at any point during the year; however, you 're only allowed to determine your investment options once a year, the SEC says.

Fees and usage

Most 529 plans come with additional fees that vary depending on the organization that runs the plan and the amount you invest. Typical fees may include include a percentage of your annual account balance, account maintenance fees and fees paid to your adviser or broker, according to U.S. News & World Report.

Also, keep in mind that 529 plans are intended to fund college educations. So, you would be required to pay penalties and taxes if you withdraw your funds without using them for eligible college expenses, the SEC says. Fortunately, the Internal Revenue Service says you can change the beneficiary of a plan or transfer the funds to another plan for an eligible family member. That means if one of your children decides not to go to college, you might be able to use the funds for his or her sibling.

And last, but certainly not least, the SEC says 529 plans are considered assets and may affect your child's chances of receiving financial aid.

If going to college is in your child's future, then purchasing a 529 plan can be a smart way to prepare for college costs. The College Savings Plans Network offers a 529 Plan Comparison tool to help you compare your state's plans by tax benefits, fees, contribution limits and more. Spend some time researching your options so you can make an educated decision on the best choice for you and your child.