Did you invest in a prepaid tuition plan? Is your child about to go off to college? Congratulations if you answered yes to both of these questions! You probably got a great rate of return and have some of your son’s or daughter’s tuition already paid. And here’s some more good news: all that investment growth you got from paying for college in the past will be tax free to you when you use the Plan to pay for college today. All prepaid tuition plans are 529 plans (except the Massachusetts Prepaid Plan, which derives its tax-free status from another section of the federal tax code) and share all of the tax benefits of 529 savings plans.
Unfortunately, using your prepaid tuition plan is not as simple as writing a check to the college. You’ll want to take some steps now so that you use the plan properly when the bill comes due.
Contact the Plan and Obtain the Paperwork You Will Need to Use it to Pay for College: Most prepaid tuition plans will make payments directly to the college in which your child enrolls. You will need to sign a form disclosing the college’s name and authorizing the plan to pay the college directly. This form may be required every semester that you want to use plan funds to pay for college.
Compare the Plan’s Value to Your Total Cost for College: Most prepaid tuition plans are designed to cover the tuition and required fees at the participating institutions. Unless your plan had a room and board supplement (and you purchased it), you may still have significant out-of-pocket expenses to pay.
And Watch the Tax Breaks! There are three tax breaks for parents who pay for a child’s education: the American Opportunity Credit, the Lifetime Learning Credit, and the Tuition and Fees Deduction. Coordinating the use of a prepaid tuition plan and these higher education tax credits can be difficult, and you should contact a tax planner or your plan sponsor for guidance.
Finally, here are some other things to consider regarding prepaid tuition plans:
The Down Side of Scholarships: Do you have a prepaid tuition plan and did your child receive a full or partial tuition scholarship? Be prepared for one or more surprises. Most prepaid tuition plans pay less if the payment covers costs other than tuition and fees (such as room and board). If the scholarship pays for tuition and you use the plan to pay for these other expenses, the plan may send the college a smaller amount than you expect. Want to use the plan to pay tuition and fees, and apply the scholarship to room and board? If the scholarship donor allows this (not all will), the scholarship may become taxable income to the student! Scholarships are tax-free only if they pay for the student’s tuition, mandatory fees, and required books, and supplies. If the plan pays tuition and fees, then the value of the scholarship that exceeds the costs for mandatory books and supplies must be reported as income on the student’s income tax return.
What if My Child Chose to Attend a Non-Participating College? Most prepaid tuition plans will pay one amount to “participating colleges” and a second, usually much smaller amount, to “non-participating colleges”. If your child chooses to enroll in a non-participating college, contact the plan to make sure you know how to use the fund to pay for the college (it may be different from the way you’d pay for a participating college) and find out how much the plan is worth at that out-of-plan school.