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Avoid These Common Prepaid Tuition Plan Mistakes

Parents can miss out if they wait to purchase credits from these college savings plans.

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Maryland mom Lisa Scott didn't think she could afford to pay for all four years of her 7-year-old daughter Lilly's college education. Then she attended a parenting seminar at her local library that included information on the Maryland Prepaid College Trust, a specific kind of tax-advantaged college savings account where parents prepay future tuition.

After her own research on similar 529 college savings plans offered by her state and others, she chose a program where she prepaid tuition for two years of community college and two years at a Maryland state university. For her budget, she chose annual lump sum payments.

She said her research indicated investing the money through a local bank would have been a mistake. With tuition rising, she would have lost out on securing tuition prices for Lilly's education.

Avoiding 529 plans altogether would have been a mistake – and is just one of the mistakes parents can make in considering prepaid tuition.

[Learn the truth behind these prepaid college tuition plan myths.]

1. Waiting too long: The advantage of a prepaid plan for college tuition is that it allows parents to lock in today's tuition rates. Since tuition generally rises annually, parents will have to pay more for tuition credits for every year they wait.

In Nevada, where the state prepaid tuition program was launched in 1998, a couple with two children born in 1999 and 2001 would have saved two-thirds the cost of tuition if they had acted when their children were born.

The contract price for four years of prepaid tuition at a Nevada state college was $6,800 in 1999 and $7,500 in 2001, according to the state treasurer's office. If the family waited until 2012 to purchase prepaid tuition, they would have paid $22,700 for each child.

Parents waiting to buy in because they think they can't afford to purchase tuition in advance should look into payment plans or buying additional smaller numbers of tuition credits as they can afford it.

Depending on the plan they are purchasing, they can buy a semester or less of tuition credits or make monthly payments on a larger amount of tuition purchased.

"Buying the number of credits or years you can afford is a good strategy because you can usually buy additional years later – although at a higher price," says Joan Marshall, executive director of College Savings Plans of Maryland.

When Scott chose her plan, she looked at all the options her state offered, which included monthly payments.

[Avoid these common college savings mistakes.]

2. Thinking you can't have other 529 plans: In addition to prepaid tuition plans, parents can invest in either direct-sold or broker-sold college savings plans at the same time.

"Parents who can afford to do both should buy the prepaid plan for the tuition portion and save in a 529 plan for other expenses" such as room and board, books and fees, says Nevada State Treasurer Kate Marshall (no relation to Joan Marshall). "They complement each other."

In addition, Maryland's Joan Marshall says, parents often misunderstand that both kinds of 529 plans qualify for state and federal tax benefits.

Scott's daughter already knows she wants to be a veterinarian. So Scott is putting aside money in a traditional 529 plan in addition to the money she's saved for Lilly's first four years.

[Find out about prepaid private college tuition plans.]

 3. Not considering all options for using credits: Prepaid plans can be used in a variety of ways. "If parents buy a prepaid program with university credit hours and their child goes to community college, make sure they understand how the credits are applied," Kate Marshall says.

Because community college credits are cheaper, "it may be advantageous to pay the community college credit hours out of pocket, and save the university credit hours for use when children transfer to the university, or to downgrade the plan to a community college plan," she says.

There are different options depending on the plan for how any credits remaining after a student has completed a bachelor's can be used, such as transferring the money into a traditional 529 plan or applying the value of the credits toward graduate school tuition.