How to use a tax refund or profit-sharing check to save for college
Susan Tompor, Detroit Free Press
Updated 11 min read
Getting a windfall of cash — say, a profit-sharing check from one of the Detroit Three automakers or maybe, a sizable income tax refund — can spark some savers to want to set aside more money, maybe even for college.
Sure, they might save cash from a payout after covering other bills and obligations. Fortunately, though, more college savings plans offer options that do not require that you plunk down thousands of dollars at once.
The Michigan Education Trust, Michigan's prepaid college tuition program, quickly built up a name in the late 1980s with what was then a novel "pay now, learn later" approach. The phones, according to a Detroit Free Press report, were "ringing off the hook" in late 1988 as savers rushed to meet a deadline then to buy the brand new MET contracts. The minimum deposit nearly 36 years ago was $1,689 for each year of tuition to cover a newborn or $6,756 to prepay four years of college. The price tag, as it works now, ended up being higher for older children.
The promotional push in 1988 noted then that parents, grandparents and others could prepay up to four years of tuition for any child at any of the state's 15 public universities and then 29 community colleges.
But today, frankly, the price of a lump sum contract can scare anyone out of writing a check. Who wants to pony up essentially the cost of a down payment on a new car to pay for a year of college tuition down the road? Some do but many find the price beyond their budget.
Fortunately, there are other newer "Pay-As-You-Go" options, too.
Prepay a semester at a time with MET
College tuition costs have gone up astronomically since 1988, driving up the price of prepaid tuition contracts.
Big tax refunds, as well as profit-sharing checks from the Detroit Three automakers, are often used to pay off debt or cover bills. But some of that extra cash creates an opportunity to save more, as well.
Currently, parents or grandparents can pay $16,230 for a baby born Dec. 1, 2023, or after to cover two semesters or one full year under the full benefits option. For just one semester, the lump sum cost is $8,115. Those prices are effective Feb. 1 through Jan. 31, 2025. One semester equals 15 credit hours.
The full benefits plan is the most costly option but can provide the biggest bang for the buck, if the student ends up attending a high-cost university, such as Michigan Technological University, the University of Michigan and, often, Michigan State University. The full benefits plan covers full in-state tuition and mandatory fees at any Michigan public university, including pricey ones.
A lower-cost limited benefits option would cover full tuition and mandatory fees at many public Michigan universities, but offers only limited coverage currently at Michigan Tech and U-M Ann Arbor.
Currently, MET will pay full tuition for the credits purchased at MSU under a limited contract, according to Megan Patino, deputy director for the Michigan Education Trust for the Michigan Department of Treasury. That's if a student with a limited benefit contract attends MSU during the 2023-24 academic year. It doesn't always work out this way.
Full tuition coverage at MSU under a limited MET contract has only been available three out of the last 20 years, Patino said. The limited contract fully covers tuition at specific public universities and community colleges only when "tuition does not exceed 105% of the weighted average tuition of all Michigan public four-year universities."
Under the limited plan, tuition at MSU might be only partially covered in future years, Patino warned, "since it is still one of the most expensive universities in Michigan."
Money in a MET plan can be directed to a private college in Michigan, out-of-state college or trade school. Full tuition isn't often covered. But some out-of-state institutions have lower costs than the Michigan average tuition rates, such as Florida, Patino said, and tuition at some Florida colleges is covered in full.
Refunds can be made if a beneficiary decides not to attend college or the student gets a full scholarship. Prepaid plans typically cover tuition, not room and board.
Another MET option: Buy by the credit hour
Given the high cost of a lump sum contract now, the "Pay-As-You-Go" option in the MET plan is popular. Savers can spend hundreds, not thousands of dollars initially, to prepay just one credit hour. For many, we're talking about the price of some attractive flat screen TVs.
One college credit for a baby born Dec. 1, 2023, or after, for example, is now priced at $541 for a full benefits credit. The cost jumps up to $781 a credit for a student in the 12th grade.
Patino said 53% of the new contracts opened in 2023 were "Pay-As-You-Go" contracts for the MET plan. The flexible option was introduced in 2016. Savers must buy a minimum of one credit in the plan of their choice but then can add $25 or more at any time. Patino said about 75% of purchasers contribute more than the $25 minimum when they set aside more money.
The "Pay-As-You-Go" plan also has a way for friends and family to contribute for birthday gifts and holidays.
"I have two little ones of my own, so I know how many toys you can get," Patino said.
Monthly MET payment plans
It's also possible to set up a monthly savings plan to buy a full year's of tuition — or more — if your budget allows.
A four-year monthly MET purchase plan for a fourth-grader, for example, is $207 a month to buy just one semester of tuition in the full benefits plan. Yet, for many families, a monthly college prepaid tuition payment can look like another utility bill.
In 2023, MET sold 1,351 contracts totaling $26 million in prepaid tuition, plus an additional $5.5 million in extra contributions to existing Pay-As-You-Go contracts.
Patino said MET contract sales were up 7% last year from 2022, making 2023 the best year since before the pandemic.
A more flexible path: A 529 college savings plan
After a landmark tax decision in 1996, savers began hearing more about qualified tuition plans known as 529 plans based on the relevant section in the Internal Revenue Service code. Many even now dub May 29 as "529 Day" to highlight tax-advantaged college savings plans. MET is classified as a 529 prepaid tuition savings plan.
But another even more popular option for savers is a 529 college savings plan, such as the Michigan Education Savings Program, which was launched in November 2000. Savers can open an account for as little as $25. The goal isn't to prepay tuition but, instead, build up savings.
The state's MESP plan is one of 15 college saving plans nationwide that ranks as "silver," according to "Morningstar 529 Ratings: The Best Plans of 2023." Morningstar reviewed 54 college savings plans across the country, which represented more than 90% of $415 billion in assets invested in college savings plans as of August 2023. The review doesn't include prepaid tuition plans.
Another 17 plans in that group were ranked below as "bronze."
A silver rating indicates a strong option for savers, according to Morningstar. Much can vary among plans, but, in general, silver would reflect some combination of well-researched asset allocation approach, a robust process for selecting and monitoring underlying investments, an experienced investment team, stable oversight from the state, and low fees. A specific plan, for example, might not necessarily have lower fees and still get a silver ranking if other features had exceptionally high marks.
Silver isn't as high as the gold rating, which went to the Utah "my529 plan," which has held that designation since 2012, and Pennsylvania’s 529 Investment Plan, which was upgraded in the latest rankings from silver.
The Michigan plan lost a bit of its edge over the competition and was downgraded from gold, according to Morningstar, as other 529 plans caught up to Michigan’s "straightforward and low-cost approach that made it a top pick in previous years."
Adam Millson, associate director of multi-asset and alternative strategies for Morningstar Research Services, told me that Michigan's downgrade was driven by its rating for what Morningstar calls its "process pillar," which went from a high to an above average rating.
The "process" rating reflects the plan's approach to asset allocation, its glide path that changes the asset mix over time to limit risk closer to a student's college years, underlying manager selection and risk management for the investment options.
"The silver rating does show we still have a lot of conviction in this plan, and believe that it will deliver positive outcomes for education savers," Millson said. Ratings are reevaluated every year.
He said the Michigan plan remains "a very solid plan."
Savers have some flexibility when it comes to using their 529 plan money. Money in the Michigan plan can be used for registered and certified apprentice programs, as well. The money would be withdrawn tax-free at the federal level but it is currently not tax-free for Michigan income taxes. "For Michigan taxpayers, these withdrawals are subject to recapture of tax deduction, state income tax as well as penalties," according to an MESP fact sheet of frequently asked questions.
Patino said bipartisan legislation in Lansing is seeking to "add apprenticeship programs to the list of qualified higher education expenses in the MESP law, so it should hopefully be tax-free for Michigan income taxes soon."
Beginning in 2024, money in a 529 savings plan can be rolled over into a Roth 401(k) for the beneficiary without a tax penalty if that money isn't needed for education. The rules are very specific. Up to $35,000 in total over a lifetime can be rolled over to a Roth individual retirement account for the beneficiary. But you can only transfer up to $7,000 in 2024 for someone younger than 50, based on the maximum allowable annual Roth contribution. The 529 plan account must have been opened for at least 15 years.
The popularity of prepaid tuition plans overall has been declining, according to Mark Kantrowitz, a student loan expert. About a dozen prepaid plans, including Michigan's MET plan, remain open to new savers, he said. Many states that once offered prepaid tuition plans no longer offer the plans to new savers.
The 529 savings plan in Michigan, Kantrowitz noted, is now bigger than its prepaid tuition plan.
The Michigan Education Trust had nearly $1.1 billion invested in 33,179 accounts, according to a report issued last September by the College Savings Plan Network, a division of the National Association of State Treasurers.
By contrast, Michigan Education Savings Program had more than $7 billion invested in 306,704 accounts.
The Michigan 529 Advisor Plan, which is sold by financial professionals, had another $1 billion invested in it with 55,718 accounts.
Follow the rules for tax breaks
Savings can grow, free of federal and state taxes while in the 529 savings plan account. No income tax is paid on the earnings in a 529 plan when withdrawals are used for qualified expenses. A nonqualified withdrawal is subject to income tax and a 10% federal tax penalty on earnings.
Under a 529 savings plan, contributions can vary and families select their own investment options — which can gain or lose value over time. The savings plan can be used for either tuition, room and board or both. Savers can invest directly into the MESP and select their own investment options, including age-based plans that take on less investment risk as the child moves closer to college.
One draw for many families is the state income tax break for contributions into the MET and the MESP.
Michigan taxpayers can deduct the full amount of what they paid for a MET contract from their taxable income on state income tax returns for the calendar year that the contract was bought. The same holds true for "Pay-As-You-Go" contributions in a given year. Deductions are taken on Schedule 1, Line 18.
Michigan savers also can deduct the amount contributed to the Michigan Education Savings Program in a given calendar year on Schedule 1, Line 17, of the 2023 Michigan income tax return. That deduction is limited to up to $5,000 for individuals each year from their Michigan adjusted gross income and up to $10,000 for married couples filing a joint return.
To deduct the amount on the 2023 return, though, contributions or purchases must have been made by Dec. 31, 2023.
