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The 529 Plan: Prepaid Tuition

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By Robert Brokamp

First conceived on a wintry night (wink, wink) in the 1980s, prepaid tuition plans became part of Section 529 of the Internal Revenue Code in 1996. Prepaid tuition plans are just what they sound like: Your investment buys a given number of tuition credits at a public college or university at today's prices. Thus, regardless of what increases occur in tuition rates in the future, the number of quarters/semesters/years purchased today are guaranteed for the future. The state agrees to pay those costs later at whatever price that might be -- but only if the student attends an in-state school.

Prepaid tuition plans are most attractive to conservative investors since the plan guarantees to pay for their student's tuition. Similarly, prepaid tuition plans might be a wise choice for students who are three to seven years away from college since, with such a short investment time horizon, they should be playing it safe. However, since the risk of being able to cover the rising costs of tuition is being assumed by the plan, you'll pay a premium; you can't expect someone to take on a financial risk for nothing. (Also, keep in mind that most prepaid tuition plans do not allow enrollment of students beyond the 9th or 10th grades.)

Because it's difficult to anticipate where a student will go to college, most states have provisions for using the savings in the plan to pay for tuition at a private or out-of-state school. However, states will not guarantee that the credits in your account will cover tuition at another school. Your contract will be valued based on the state's tuition rates, or you'll just get back your contributions, with modest interest.

Some prepaid plans cover just tuition and fees; other plans will also pay for room and board. If you participate in a plan that does not cover room and board, you'll have to save separately for those expenses. Like the other college savings options, a prepaid tuition plan can be transferred to another family member.

See the College Savings Plan Comparison Chart for the whole enchilada.

How to choose a prepaid tuition plan

Making this choice is simple: Does your state offer a plan? (Only 18 states do.) If your state has a plan, that may be your only option. Most programs are open only to contributors or future students who are residents.

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