Should I Invest in a Prepaid College Plan?

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What if you could lock in your child’s college tuition at today’s prices? Prepaid college tuition plans are now offered in ten states and for those who are worried about the rising price of a college education along with the uncertainty of investment markets, buying tomorrow’s education at today’s prices seems like an easy decision.

But financial planners are largely unconvinced. Although this chart shows that the college tuition inflation rate has long been much higher than the general inflation rate, the decision, according to the 89% of financial planners who don’t use these prepaid plans, isn’t as easy as the numbers may indicate.

What are Prepaid College Plans?

Most parents are now familiar with 529 plans. These are named after section 529 of the IRS code that provide tax incentives to those who begin saving for their child’s education long before they reach college age. There are two main types of 529 plans. The first is a college savings plan that allows money to be deposited in to an investment account that grows until the child reaches college age.

The second type is a prepaid college plan guaranteed to grow at the rate of college tuition inflation. If one full year of a state college education was purchased today, it would always be worth one year of a state college education, even if that is 15 years from the year of purchase. (read more here)

Most plans require that either the account owner or the beneficiary be a state resident when the account is opened which makes the prepaid tuition option open to a relative few amount of people but for those who are eligible, why isn’t the financial planning community not so enthusiastic about the idea?

Like a Pension

Anybody who has been in the full time workforce for the past 20 or more years may have had a pension as their main retirement vehicle. Although pension benefits are locked in, pension plans have been replaced with 401(k)s or other retirement vehicles like this for many employees.

Companies found it increasingly difficult to guarantee a payout to their employees in an increasingly challenging investment market that offers no guarantees. The same thing has taken place in these prepaid tuition plans. Eight of these plans have been closed to new investors for more than a decade because of a shortfall in funds.

An unfortunate combination of less than expected investment performance along with college tuition inflation rates higher than forecasted have resulted in funds like the Illinois fund seeing a 30% shortfall. This means that the fund can only meet 70% of its obligations.

Is It A Good Idea?

Many of these prepaid plans are almost fully funded after a tough couple of years but they’ve learned valuable lessons that make these plans out of reach for many households. The Washington plan is assuming an annual rate of college tuition inflation of 19% for the next two years—much higher than the 7% increases they assumed in their previous models.

In Maryland, it costs a lump sum $40,095 to enroll an infant in the prepaid plan with the assumption that it will cost $139,750 for four years of college when that child reaches college age.

Although these prepaid plans are in a much better financial position than in the past, the sometimes large upfront costs are prohibitive for many.

Bottom Line

Remember that nothing is guaranteed. Nobody knows what will happen with the world’s economy over the next 20 years so purchasing these plans solely on the basis of the guarantee may not be a wise choice. The better choice may be to supplement a prepaid plan by paying in to a 529 account for added protection. Like every investment decision you make, never put all of your money in to one product.

{ 9 comments, please add your thoughts now! }

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9 Responses to “Should I Invest in a Prepaid College Plan?”

  1. Matt K says:

    unclear/uninformed about this…. that $40k that you put in up front, is that good only if your child goes to a public maryland school? what if they go out of state for college? or what if they don’t get accepted into college? what if they get an athletic scholarship and they don’t have to pay for college?

    is it still worth $139k in ~18 years in all those scenarios?

  2. Squeezer says:

    Matt, I was going to ask the same question

  3. ghina says:

    If they go out of state they get reimbursed the tuition at UMCP. So you don’t really lose the money.

    If they don’t get accepted into college, you can change the beneficiary to someone who will, like another kid, or graduate school.

    Don’t know if it could be used in vocational school, or if it can be split to multiple beneficiaries.

    You roll the dice with every decision you make, how likely is it that people reading this blog who have kids will get a full scholarship?

    You might be able to go to a school that only offers a partial scholarship because you planned ahead.

    Heck..maybe I could make myself the beneficiary after junior is launched?

  4. freeby50 says:

    I believe in general the plans do not lock you into spending in that state. I know Washington and Maryland let you spend the money anywhere. BUT if you go out of state then you don’t get 100% tuition to any school, you get some amount of monetary equivalent to use to spend. If you use the money out of state then thye often pay you an amount of cash equivalent to the average for in state tuition. However other plans may differ.
    The exact way that the plan works depends on the state in question. They are all a little different. The only way to know exactly how it works is to read the documents for the state in question.

    What happens to the money or how the state handles the plan IF they decide to close it down will also vary from state to state. With a lot of states having budget problems that can be a real risk. You’d also have to read the plan details to figure out what might happen exactly if they shut the plan down. I assume you’ll get your money back more or less. But they might only promise to return the principal plus some small amount of interest.

    As far as I know only around a dozen states actually have open pre-paid tuition plans right now.

  5. mikestreb says:

    What states? How about some links?

  6. Scott says:

    I agree with freeby50. I looked at this plan here in Virginia for our 1yo son and saw the bit about giving you funds equivalent to “average” tuition rates if you went out of state or private. I haven’t run hard numbers, but from everything I could tell, this is only ever a good deal if you and your child are dead set on going to the best in-state school available. If you sway from the in-state path, you will be subsidizing others’ educations.

  7. freeby50 says:

    mikestreb theres a link in the article to the finaid page that talks about pre-paid plans. IT directs to this list :

  8. rlaw100 says:

    I don’t like these plans, they all ride on the assumption education costs will continue to skyrocket.

    Private Education is already extremely expensive. I don’t think prices can continue to rise. Not with local colleges getting more and more competitive in terms of their offerings. Can you really justify spending 3-5 times more for a more prestigious university.

    How about 5-10times more, Local Colleges have tuition increases of maybe $100-$200 every 2-4 years and these are long drawn out fights with students. The gap is just getting too big.

  9. Aaron B says:

    What makes me nervous about the Massachusetts prepaid plan is it’s not a true 529 plan. It uses state-issued bonds so it’s still tax-advantaged for in-state schools, but if you move somewhere else and get the cash equivalent for a out-of-state school, your new home state may tax you on the interest earned.

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