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Prepaid Tuition Programs: How They Work

May 16, 2011 Jennifer Williamson, Distance Columnist | 0 Comments

Pre-paid tuition programs are designed to allow parents to pay college tuition ahead of time at today’s prices—rather than tomorrow’s. Savings are assumed based on the projection that college tuition prices will continue to rise, and if that’s true, families could save a significant amount of money by using these plans. Here’s how they work.

Prepaid tuition plans differ from other college savings plans that generate returns not tied to tuition increases. These other college savings plans could possibly give you a higher return than the rate of tuition inflation, but there’s also the possibility that your investment could diminish in value. With prepaid tuition plans, it’s a surer bet that tuition will continue to rise.

Prepaid tuition plans are sponsored by state government. They work differently state-by-state, and you usually have more flexibility with newer plans. Under these plans, you “buy” tuition for a child at a set price, either in full or in installments. The state guarantees that your child will have the money to attend college at an in-state public school or another participating school, and you can defer payment of federal income tax on your payments until the money is withdrawn.

Piggy Bank On Stack of Books

Prepaid tuition programs allow families to lock in a tuition rate that’s projected to be lower than future rates—and start paying for college immediately.

These plans will benefit families if tuition costs rise faster than the current average inflation rate. The plans aren’t the best deal for everyone—for instance, you may earn more by investing the money in the stock market, especially if your child won’t enter college for five years or more. The plans are a better option for parents who didn’t start saving for children’s college until after the child entered high school, because they won’t have enough time to see real stock market returns.

The plan does have its drawbacks. If your child attends college out of state, at a private college, or at a non-participating college, for example, you may only get some of the benefits. You may or may not be able to transfer the funds to a sibling. And if your child doesn’t want to go to college at all, you’ll be subject to strict penalties. Some plans impose harsh restrictions on withdrawing money for any purpose except payment of college tuition.

In addition, prepaid tuition plans can reduce the amount of student financial aid you’re eligible for—because they reduce your tuition costs. Even if you fall under a category of high financial need, you could be penalized for using the plan. If you saved the money under a different type of plan, however, you may be eligible for more financial aid—because those savings don’t directly affect the amount of tuition you pay.

One of the most troubling aspects of prepaid college tuition plans is that they’re not as safe as some parents have been led to believe. With many states experiencing shortfalls, prepaid tuition plans have come into financial trouble—and some states are not required to bail the plans out if they fail. In Alabama, for example, the fund almost ran out of money—and lawmakers only acted to repair it after a political firestorm.

Prepaid tuition programs allow families to lock in a tuition rate that’s projected to be lower than future rates—and start paying for college immediately. The plans are backed by the state, but state budget shortfalls have left some plans in crisis. The plans’ lack of flexibility can be a problem for many families—especially if a student decides to attend an out-of-state, private, or out-of-network school. And prepaid tuition plans may not make as much sense financially as investing in the stock market or in a different college savings plan that won’t have a negative effect on financial aid. Before you enroll in a prepaid savings plan, talk to a financial professional to determine the best choice for you.


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