SparkNotes

Prepaid tuition plans allow you and your parents to pay for college now, at current costs, rather than waiting and facing skyrocketing prices. A prepaid tuition plan guarantees that if you buy four years’ worth of tuition right now, at current costs, you’ll be able to attend four years of college later on without having to pay the increased cost of tuition. This is a significant savings. In the past decade, private college tuition has risen 42 percent and public college tuition 47 percent. Tuition will likely rise, on average, 5 percent each year for the next decade.

When you redeem the tuition credits you’ve purchased, their maximum value depends on the average tuition of in-state public colleges. If you decide to go to either an in-state private college or an out-of-state college, you can usually apply the tuition you’ve bought toward that college’s tuition. However, you’ll have to make up the difference between the value of the average public college’s tuition and the cost for tuition at the private or out-of-state college. The exact details of these plans vary from state to state.

Though prepaid tuition plans are a great deal in some ways, you’ll see in just a moment how they can adversely affect your chances for need-based aid.

A 529 college savings plan allows you, your parents, or anyone else to contribute to the future costs of college and get some tax benefits in the process. Unlike the prepaid tuition plans, the college savings plans don’t come with any guarantee on returns. Like regular investments in the stock market, there is a chance that you could actually lose the money you’ve invested in them.

College savings plans often allow contributors to choose how their money is invested. Options include higher-risk equity funds for potential long-term growth or safer fixed-income investments when college is fewer than five years down the road.

Whereas you can use the prepaid tuition plan only for tuition and mandatory fees, you can use college savings plans for any COA expenses, including room, board, books, and supplies.

• Earnings grow tax-deferred.
• Distributions are tax-exempt when used for college costs.
• Accounts benefit from state-tax exemptions or deductions.
• You can open 529 accounts for both relatives and friends.
• You can choose how your money is invested in a 529 college savings plan.
• Accounts can be transferred to other family members.
• Accounts can be refunded, albeit with penalties.
• There are no income limitations for who can open a 529 plan.
• IRS gift-tax rules offer an accelerated giving benefit.
• You have fewer time limits for use than other college savings plans.

• 529 plan fees may make this a poor choice for short-term planning.
• Withdrawing funds results in a 10 percent penalty.
• Funds for anything but school will be taxed.
• Tax benefits are set to expire in 2011, barring legislation.
• Prepaid tuition plans may reduce eligibility for other financial aid.
• College savings plan accounts in your name will be assessed at 35 percent.
• Prepaid tuition plan funds must be used within a limited time period.
• Time extension may come with a penalty.
• Funds can’t be used for most foreign schools.
• Funds can’t be used for schools not considered “eligible institutions of higher education.”

• Unlimited investment options.
• Few limits placed on where funds may be used.
• May be set up at virtually any brokerage firm.
• No expiration date for Coverdell tax benefits.
• Tax-free withdrawals for qualified educational expenses.

• $2,000 annual contribution limit.
• Varying setup fees and other administrative costs.
• Income limitations on who may participate.
• Counted as a student asset in the needs-analysis formula, which greatly reduces other aid eligibility.
• Generally must be used before the student reaches 30 years of age.

If your parents really like living on the edge, they might opt for a custodial account. Also known as Uniform Gift to Minors Act (UGMA) accounts or Uniform Transfer to Minors Act (UTMA) accounts, these plans can be set up with just about any brokerage firm or mutual fund company and have some tax advantages. The main advantage has to do with the rate at which custodial account earnings are taxed. The first $750 is exempt, the next $750 is taxed at the child’s lower federal rate, and anything beyond is taxed at the custodian’s federal rate. In order to qualify for this benefit, you must be younger than 14.

Once you reach the age of majority, anywhere from 18 to 25 depending on what state you live in, all funds within the account become your property. At this point, you’re legally entitled to spend the money on anything you want—not just college. Of course, if your parents set up a custodial account with the intention of your using it to pay for college, you’ll probably want to do just that. Your parents might view your freedom of choice as a risk.

Ah, yes, backed by the full faith and credit of the United States government, savings bonds have been around since 1935. Alas, like many things that have been around since 1935, savings bonds just don’t seem as cool as all these new programs, with their fancy acronyms and code numbers. However, they do have many of the same benefits, including tax exemption when used to cover the costs of education. And of course, the full faith and credit of the United States government never really goes out of style, does it?