With stock market volatility, how can you be sure that the money you save will grow to the fund you anticipate to pay for your child’s education? You can’t. What you can do, however, is use a savings option that ensures tuition and fees will be covered-in whole or in part. This option is called a prepaid tuition plan.
Contributions to a 529 prepaid tuition plan buy tuition credits. The value of the contributions increases in tandem with the cost of tuition. For example, you buy one full year’s worth of tuition at your state university for your newborn. When your child attends the school 18 years from now, she will have one full year covered, regardless of what tuition actually costs at that time. Thus, there is no risk to principal; whatever the stock market does, you are assured that your contributions will pay for that amount of tuition you had expected. These plans typically outperform savings you could achieve on your own through CDs and other safe investments.
However, there are some drawbacks to consider:
States with prepaid tuition plans. Not every state offers this savings option. States with such plans include: Alabama, Colorado, Florida, Illinois, Kentucky, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Ohio, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington, and West Virginia.
Private prepaid tuition plan. There is also a sponsored by a consortium of more than 250 colleges and universities nationwide, including many Ivy League and other prestigious institutions, that offer a separate plan.
There are not federal tax deductions or credits that can be claimed for contributing to a prepaid tuition plan (there may be state tax breaks for residents). However, earnings grow tax deferred and, when tuition credits are used for the beneficiary’s schooling, there is no tax to you, the contributor, or to the beneficiary.
Caution: Cancellation of participation in the plan and withdrawals are subject not only to substantial penalties imposed by the plan, including loss of principal. There are also a 10% tax penalty, as well as any income tax on earnings excess of your contributions.
Tax credits, including the foreign tax credit, the minimum tax credit, the retirement savings contribution credit, and the residential energy credit, increased by 8.2% in 2007 to $63.8 billion. The child tax credit, dependent care credit, and education credits declined slightly.
Source: Statistics of Income Bulletin, Fall 2009View all factoids