Prepaid Tuition Plans

If you've looked at your 529 statement lately, you might have wondered if there's a college savings option that earns a return without the volatility we've seen for the last six months. Prepaid tuition plans are one such option. Prepaid tuition plans have pros-- like guaranteed returns-- but also some cons to make up for those. Is a prepaid tuition plan a fit for you?

Let's start with the basics: What is a prepaid tuition plan? In a 529 savings plan, you invest an amount you choose in an investment allocation that you choose. When the time comes for college, you have a savings balance equal to the market value of your contributions and the returns they earned. If you deposit $1,000 and it earns 6% annually for 10 years, you'll have $1,790. If you earn 7%, you'll have $1,967. If you earn 2%, you'll have $1,219. With a prepaid tuition plan, you buy future tuition at today's price. If tuition costs $10,000 per year now and you contribute $1,000, you'll have 1/10 of one year of tuition when the time comes.

One of the big drawbacks of prepaid tuition plans is that there aren't a lot of them, and they serve limited groups. Most prepaid tuition plans are run by states and limited to residents of those states. Currently, these states offer prepaid tuition plans: Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas and Washington. Some state plans give you the actual inflation rate of in-state college tuition regardless of where you attend; others only give you that rate if you attend in-state. The Private College 529 is open to anyone but you only get full tuition inflation credit if you use it at one of the plan's approximately 300 participating colleges. Otherwise, you receive a lower interest rate.

State-sponsored prepaid tuition plans typically offer the same state income tax benefits as 529 savings plans, but it's worth reviewing the plan's details before deciding whether to invest.

Prepaid tuition plans can also only be used for tuition and fees, not room and board or books. Most have limited enrollment periods, and there's usually a requirement that contributions remain in the plan for a certain period of time, generally at least three years.

Prepaid tuition plans can be great for students who are close to college, since earning a guaranteed inflation-based rate of return can help savings keep pace with inflation with minimal market risk. But they're usually best added as a complement to an existing 529 savings plan, since most families need savings for room, board and books, too.

Here's a nifty trick for anyone whose student will be attending a Private College 529 member school starting this fall: The Private College 529 resets their tuition rates annually every July 1. So through June 30, tuition credits are bought at the current school year rate. That means that contributing to an account before June 30 locks in this year's tuition rates. Note that funds need to remain in the account for three years, so they could not be used before senior year of college.