Section 529 of the tax code established two types of higher education investment plans that receive preferential tax treatment. The 529 college savings plan allows assets in the account to grow and withdrawals for college expenses to be made tax free. The second type, 529 prepaid tuition plans, also known as prepaid educational arrangements or PEAs, provides tax-deferred growth on savings for tuition, based on the current cost of that tuition.
PEAs can be purchased in units, usually credit hours or a percentage of the annual tuition fee, or in contracts for one to five years of tuition. Payment can be in a lump sum or in installations. The states that administer PEAs guarantee that your investment will, at the very least, match college tuition increases. For that reason, these plans are typically much more conservative than other types of college savings, so they may not be appropriate late-stage college saving.
Because PEAs can be purchased for the student by anyone, they allow aunts, uncles, grandparents and even unrelated benefactors to help with educational costs and, depending on the state, receive a break on their taxes. Most PEAs are transferable to other members of your family – including parents, aunts, uncles, brothers, sisters and children – if the original beneficiary decides not to attend college. The distributions from the PEAs are not taxed by the federal government, as long as they’re used for tuition and fees.
The primary drawback for PEAs is that states administering these plans usually require that the funds be used for a school in that state. That may be a difficult commitment to make if your child is young and his future career pretty much up in the air, although the ability to transfer to another family member gives you one option if plans change.
PEAs are just one of the extensive opportunities for securing your child’s future and typically contain less risk. By meeting with a trusted financial professional and finding out your options, you move one step closer to helping your child take part in the most important investment of their lives: their education.