A prepaid tuition plan lets you purchase units of tuition for any state college or university at today's prices. A semester's worth of prepaid tuition purchased at 2005 prices would pay for a semester's worth of tuition at any future date, no matter what the cost at that time.
Four years of tuition purchased in 2005 would pay for four years of tuition at any in-state university starting in, say, 2015. Industrious parents could pay for four years of college while their son or daughter is still in elementary school. Currently there are more than a dozen states that offer prepaid tuition plans.
Most plans allow anyone -- from any state -- to contribute to a 529 prepaid tuition plan. If you start a 529 account for your child in your home state, grandparents or even friends can contribute to it, even if they live across the country.
For example, if you start a 529 plan in Minnesota, relatives or friends who live in Oregon can still contribute. The caveat is that some states may charge residents a tax on earnings on out-of-state 529s.
A student could choose to apply tuition purchased in a prepaid program to a private or out-of-state college, but the family may have to scramble to pay additional tuition costs. For example, two years' worth of tuition at a state university purchased in 2005 might only pay for a single semester of tuition at a private college in 2012.
Financial aid implicationsKeep in mind that prepaid plans are treated differently than savings plans when it comes to financial aid. The 529 savings plans have a relatively low impact on financial-aid eligibility, while prepaid tuition plans have a high impact. Why?
Prepaid tuition plans are considered a resource, just like a scholarship. That means you'll see a dollar-for-dollar reduction in aid when you use these plans.
Savings plans, however, are considered an asset. If the account owner is the parent (which is typical), only up to 5.6 percent of the savings plan value will be assessed for financial-aid eligibility, just like with any other asset such as like a savings account. (If the account owner is a child, however, that percentage can jump to 35 percent.)
If you have $10,000 in a 529 savings plan, for example, the financial aid could decrease by up to $560. But if you've paid for a semester's worth of college, which is now $10,000, your aid will decrease by $10,000, as though you received a scholarship.
Who offers prepaid plans?More than a dozen states currently offer prepaid tuition programs. Recently, many private colleges, including some of the most prestigious, launched their own prepaid tuition program, Independent 529 Plan. Currently there are more than 250 participating private colleges, according to Independent 529 Plan.
There's a good chance we'll see more private prepaid tuition programs offered in the future.
If your child opts not to go to school (or is not accepted at a participating school), parents have the option of transferring the account to another family member or withdrawing the money with penalties.