Pros and cons of prepaid tuition plans

The drawbacks

Prepaid plans come with several strings attached. Funds invested in a state-run prepaid plan can only be used at full value to pay for tuition and fees at in-state public colleges. Likewise, funds invested in the Private College 529 can only be used for member colleges. In both cases, room and board won't be covered and cost extra.

Should students choose a school that's outside of the plan's coverage area, parents can roll the funds over to another sibling attending college or they can withdraw the principal they invested. Some states, such as Massachusetts, provide a small amount of interest, but it's usually at or below 3 percent.

"You'd be able to get the money you invested back, but you would have lost out (on the earnings) you thought you were locking in," says Tim Higgins, author of "Pay For College Without Sacrificing Your Retirement."

Prepaid plans may not be as safe as investors think. While some, such as Florida's prepaid plan, are guaranteed by the state, others, including Illinois' prepaid plan, are not, meaning that if the plan hits a budgetary shortfall, investors could be in trouble.

"(Families) really need to ask how the (prepaid) plan is going to keep up with 7 (percent) or 8 percent of tuition inflation each year," says Higgins.

Morand adds that families can research the safety of a prepaid plan by requesting several years' worth of the plan's financial audits -- some states offer this information online -- and having a CPA review the plan's available assets versus the amount it has to pay out each year.

"If it looks apparent that the (plan) funds were growing at 6 (percent), 7 (percent or) 8 percent, but yet (tuition) prices were going up by 10 (percent) or 14 percent every year, you can't do that for very long," Morand says.

Before enrolling in a prepaid 529 plan, Morand encourages families to research a plan's security, whether it's backed by a guarantee and to ask plan administrators about what happens if the plan starts to lose money while you hold an account.

"Families have to make sure that a prepaid plan is going to be around when the student needs it," he says.


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