Prepaid college plans, formally "Qualified Tuition Programs" based on IRS Code 529, are "tax-advantaged investment [plans] designed to encourage saving for the future higher education expenses of a designated beneficiary," according to the College Savings Plans Network.
Two types of 529 plans are available, according to the College Savings Plans Network. Prepaid tuition plans, available in 13 states and offered by some institutions of higher learning, allow you to buy guaranteed tuition at today's rates. On the other hand, a 529 savings plan is offered in 49 states and invests your payments to help you save for college expenses and potentially increase the value of your investment.
According to the College Savings Plans Network, money invested in prepaid college plans grows "federal and state income-tax free," and withdrawals for higher education expenses are exempt from federal taxes.
Participation is often limited to state residents, according to Collegeboard.com, and is based on in-state, public university tuition averages. If your child opts for an out-of-state college or a private institution, the plan may not fully cover tuition and fees.
If your plans change, you could face financial penalties including a cancellation fee and an interest penalty when pulling out of a prepaid plan, according to Collegeboard.com.