Prepaid tuition plans have pros, cons

By Sandra Block
USA Today

Worried about the cost of college?

An investment in a prepaid tuition plan allows you to buy all or part of your child's future tuition at roughly today's prices. In most plans, you can invest a lump sum or make periodic payments.

Prepaid plans aren't as flexible as 529 college savings plans, which allow parents and grandparents to invest in a portfolio of mutual funds. The money can be used to pay tuition, housing and other expenses at any college or university in the country. As long as the money is used for college, investment earnings aren't taxed.

Yet 529 savings plans also carry risk. If your investments decline in value, you could lose money, cutting what's available for college.

With prepaid plans, you send the plan money; when your child starts college, tuition is covered.

Until recently, prepaid plans were primarily limited to publicly financed colleges and universities. But a new type of prepaid plan, the Independent 529 Plan, lets you prepay the cost of attending a private college or university.

For a list of schools, go to www.independent529plan.org.

Pros and cons of prepaid plans:

Pros

• They protect against tuition inflation. In the past five years, the average tuition at a public college has risen more than 40 percent.

• As is the case with 529 savings plans, gains on investments aren't taxed as long as the money is used for college. And some states let you deduct part of your contribution from state taxes.

• Some state prepaid plans allow you to spread out your payments.

Cons

• You have to be a resident to participate in a state plan, and not all states offer prepaid plans.

• Not all prepaid plans are backed by the full faith and credit of the states that sponsor them. Only six state plans offer that guarantee, and one, Ohio, recently closed to new investors. It's unlikely you'll lose your investment in a prepaid plan. But if the plan runs into financial problems, it may not pay the full cost of tuition.

• If your child decides to go to a private or out-of-state school, you can use money in your prepaid account to pay costs. But because the amount will be limited to the cost of tuition in your state, you may come up short.

• Most prepaid plans cover only tuition, and not room and board.

• Investing in a prepaid plan can hurt your chances for financial aid. Under the financial aid formula, money invested in a prepaid plan is counted more heavily when calculating how much parents can afford to contribute. Money in a 529 savings plan is considered the parent's asset, which gets a lower weighting.

• Some programs have found a way around the problem. Pennsylvania changed its plan to a "guaranteed savings" plan, which will help parents qualify for better financial-aid treatment, state officials say.