Qualified Tuition Programs

A Qualified Tuition Program (QTP) allows a significant federal income tax benefit to families by allowing a tax exemption (like a Coverdell Education Savings Account or Educational Savings Bond) for earnings that accrue under the QTP.  However, you may employ a QTP even if you don't qualify for a Coverdell ESA or an Educational Savings Bond (because of the AGI limitations).  QTPs are administered by the various state agencies and vary significantly from state-to-state.  Recent changes allow private educational institutions to establish their own QTPs.  What you are doing under a QTP is prepaying college tuition, fees, books, and (if at least a half-time student) room and board expense.

A potential disadvantage to investing in the QTP is loss of control.  You must rely on the investment programs available through the investment company.  Contributors may not directly control the investments.  This is contrary to Coverdell ESAs where investment decisions may be made by the contributor.

As noted earlier, there is no Adjusted Gross Income (pages 9-10) phase out of the tax benefits provided under QTPs.  Therefore, as mentioned, it is the best educational savings tool for upper income taxpayers, but it is also a useful one for less well to-do taxpayers as well.  When a QTP is finally tapped to pay college expenses, the income that has built up in the Program goes untaxed.  This is a recent change to QTPs that will significantly increase their use as the higher education funding tool of first choice by taxpayers of all income levels.

Example:  Mike and Lisa are in the highest marginal tax bracket (Exhibit 2, page 11).  Their daughter, Megan, is in the lowest 10% marginal tax bracket.  Mike and Lisa make a non-tax deductible contribution of $20,000 to a QTP to fund the future college education of Megan.  By Megan's first year of college, the fund has grown from $20,000 to $40,000.  The $20,000 of earnings build up without being taxed and when tapped to pay for college expenses are not taxed to anyone.

There are two different types of QTPs.  The first is a Pre-Paid Tuition Plan where future increases in tuition expense relative to the year in which contributions are made are covered.  Thus, if you fund for your child’s college expense ten years from now under such a Pre-Paid Tuition Plan and tuition expense increases an average of 4% per year over those ten years, you have earned 4% per year on your investment.  If tuition expense increases 7% on average per year over the next ten years, you would be earning 7% per year on your investment.  Typically, Pre-Paid Tuition Plans are limited to state colleges and universities under the umbrella of the particular state agency administering the Plan.  Some state agencies have ceased to provide Pre-Paid Tuition Plans, having been burned by the stock market downturn in the early 2000's.

The second type of QTP is a College Savings Plan.  These are like mutual funds in that nothing is pre-ordained.  Whatever the College Savings Plan mutual fund grows to in value is what is available to pay tuition expense with.  Thus there are risks and rewards.  Under the College Savings Plan you can invest and get more of a stock market rate of return; however, if the mutual fund tanks you may earn little or nothing or even impair your original investment.  The investment company through which you purchase your College Savings Plan will provide a systemic investment plan where typically more of the College Savings Plan assets are invested in stocks in the earlier years and are transitioned into safer bond-type instruments as the child approaches college age.

Thus, the type of QTP you pick (the Pre-Paid Tuition Plan or the College Savings Plan) can really be thought of as another study in risk tolerance (risk tolerance was analyzed in the Retirement Planning section at page 93).  If you are risk adverse and like the idea of assuring future appreciation in tuition costs, the Pre-Paid Tuition Plan probably is the way to go.  If you want maximum flexibility as to which educational institution is ultimately attended (public or private and in or out-of-state) and desire a higher (but riskier) market rate of return, the College Savings Plan would be the way to go.

An additional critical fact and another great advantage to funding a child's educational expenses through a QTP is its affect on the FAFSA application (discussed later at page 113).  The ownership of the QTP is deemed to reside in the parent or grandparent setting it up.  It is not deemed to be the property of the student who will benefit from it.

For a variety of source material on the fantastic QTPs, go to my Web site (at http://www.personal.kent.edu/~maltieri/web/guide/home.htm), click on Educational Savings and then Qualified Tuition Programs.