The federal tax on a prepaid tuition plan, as well as the income generated through plan investments, is deferrable until the funds are used to pay for college. At that point the money is taxed at the student’s then-current tax rate, which is extremely beneficial because the student’s tax rate is typically the lowest tax rate possible.
Savings plan trusts, explains Rubin, are investment accounts that parents can use to save for their children’s education. Trust plan participants can make deposits of as little as $25. The programs usually guarantee a minimum rate of return, and the funds may be used at any accredited U.S. college or university.
Unlike prepaid tuition plans, savings plan trusts do not guarantee tuition regardless of a rise in tuition prices. However, these savings plans may pay higher returns on investments than prepaid tuition plans. Like prepaid plans, funds in these trusts are federally tax deferrable until the student enters college and are then taxed at the student’s current tax rate.
Both types of plans also receive state tax benefits. These benefits will vary from state to state. State residency requirements are common among savings plan trusts. Such requirements usually dictate that either the participant or the student must be a state resident when the student is first enrolled in the savings plan trust.