Often, paying for something upfront is a way to save money and lock in a better price.
Prepaid tuition plans allow parents and grandparents to do exactly that: pay for future college tuition at current rates.
It sounds like a good deal, especially when you consider that tuition at public four-year colleges more than tripled between 1973 and 2013, according to The College Board.
But the number of states offering prepaid tuition plans is dropping. In 2009, 18 states had a prepaid option. By 2014, that number dwindled to 11 options still open to new enrollees.
Prepaid plans are available in three forms. The first, contracts, are the most straightforward. They allow plan owners to pay a tuition fee ahead of time.
The second type, units, cover a portion of a semester or year at a public institution. For example, the plan owner buys a unit worth 1 percent of the yearly tuition.
[Find the Best 529 Plan for You.]
The third kind of prepaid plan is a voucher, which is essentially a discount coupon redeemable at a college for a portion of tuition. This plan is less common than the other two, and it is the college, rather than the state, which sells the voucher.
Skyrocketing tuition costs are a key reason states began dropping prepaid tuition plans several years ago. “The states didn’t realize how expensive college would become,” says Brian Safdari, CEO of College Planning Experts, a consulting firm in Valencia, California.
Although states developed actuarial forecasting models that included tuition increases, their assumptions, in many cases, turned out to be wrong, Safdari says. “They didn’t predict that tuition at state schools would skyrocket, sometimes as much as 20 percent or 30 percent at some institutions,” he says.
As a result, many states no longer offer prepaid tuition plans to new enrollees and are simply fulfilling obligations to earlier purchasers.
[Read: The Ultimate Guide to Understanding 529 College Savings Plans.]
Florida, Mississippi, Massachusetts and Washington have a full-faith guarantee on their prepaid plans. That means the state has a legal obligation to fund the program if there is a shortfall. Other states guarantee assets currently held in the plan, or guarantee the governor will request funding from the legislature if the well is running dry. However, that may be cold comfort if states suffer overall funding shortfalls in coming years.
One drawback to prepaid tuition plans, especially when compared with 529 savings plans, is that the money only applies to in-state public institutions.
For Jerry Slusiewicz, president of Pacific Financial Planners in Laguna Niguel, California, that requirement makes prepaid plans less attractive for his clients.
“You might be in a situation where it doesn’t work if you go out of state,” he says. “The most effective way to use any of the college funding plans is to start early, but as your child grows up to be a teenager, and wants to pursue a certain career path, and wants to attend a program at an out-of-state college, you have a problem.”
Some states’ contracts or units may be applied at out-of-state schools, but often at a decreased value.
[Read: 529 Plans: The Best Way to Save for College.]
Safdari also believes the limitations of prepaid programs make them less popular than 529 savings plans but says there is an even bigger drawback. Frequently, he says, parents realize they can send their child to a private university for even less money than a state school would cost. That’s especially true when it takes five or even six years to get a bachelor’s degree from a state college, where overcrowded classes can make it difficult to quickly fulfill graduation requirements.
“A lot of parents find their child can go to a Stanford or a University of Southern California, and through different scholarships and endowments, it ends up being cheaper than going to a state school, even if you had a prepaid plan and you applied some of it,” he says.
However, Slusiewicz says there are a few situations in which a prepaid plan could be the right solution. “If it’s late in the game, and you’re making a lump-sum contribution, and your child is a little bit closer to college age, some programs allow you to accelerate payments. I could see it making sense in that situation,” he says.
Safdari agrees there may be some cases in which the prepaid option would work, but the stars have to align. He cites an example of a father who owned a business. His teenage daughter was involved with the business and eager to take it over someday. It just so happened that a public, in-state college offered an academic program that would prepare her to run the business.
“They found that the benefit of the prepaid plan – – what they spent on it versus what they got out of it — 100 percent was tangible, predictable and obtainable because they knew exactly what they wanted from this,” Safdari says.
Safdari adds that if parents have a different vision for their children’s college education and career goals, prepaid plans may not work out so nicely. “But if the parent communicates to the student, ‘We have a prepaid tuition plan, and here are the benefits,’ the student can find the best fit, both academically and socially, at a four-year or two-year institution in the state. That would be a win-win for the student and the parent,” he says.
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Do Prepaid 529 Plans Ever Make Sense? originally appeared on usnews.com
