Less prevalent than these contract types of prepaid plans are unit programs and voucher programs, which pay a portion of tuition costs using different methodologies. We'll focus on the predominant contract plan here, but don't assume that that's the type of plan available in your state. Check into your state's program, and learn all the particulars before signing up.
The attractive feature of prepaid contracts is that you don't incur any investment risk. However, the state plan takes on that risk, and if it doesn't hire investment managers that are successful, these plans may become insolvent. In that event, a plan may suspend enrollment or shut down altogether (though usually current enrollees get some protection). Programs in Colorado, Ohio, Texas and West Virginia reported problems in recent years.
Generally, the prepaid contract has residency requirements. If your kid wants to go to private school or an out-of-state school, the contract benefits may not fully cover the cost of tuition at the school of choice. Also, it may not make sense to lock into a prepaid tuition plan if there's a strong possibility that you'll move out of state in the future.
Most prepayment contracts have an expiration date, meaning that they need to be used within a specific time frame. For example, if benefits aren't used within 10 years of the time when a child reaches college age, you may get a refund of the original contribution amount. That would not be a good return on investment.
As one example, the Florida Prepaid College Plan gives account owners three options if they face an imminent expiration date. They can extend the plan benefits an additional 10 years, transfer the account to a brother, sister or first cousin of the original beneficiary, or request a refund. Account owners have to notify the plan of a decision in writing prior to the expiration date or they risk forfeiture of all funds.
Prepaid plan options
Prepaid programs typically offer a few plan options. For example, the Florida plan features a four-year university tuition plan, a community college tuition plan, and a "2+2 tuition plan" that covers two years in a community college and two years in a university.When your children are young, it's hard to know how motivated they will be to apply to and gain acceptance from a four-year university, so parents have to make an educated guess about what type of plan to buy. If you can afford the four-year university plan and high motivation levels run in the gene pool, then I'd bet on that plan. But if all you can afford is the 2+2 plan, then consider getting that. These plans are flexible anyway, so if your kid's a latent rocket scientist, you can transfer the benefits to a four-year university.
In any event, there's nothing wrong with sending your children off to community college for their first two years. What matters most from the perspective of future employers is the school from which they earn their sheepskin. Plus you can really go places regardless of where you start your college career. According to an item that ran in the Wall Street Journal last week, 22 members of Congress have community college degrees, and 11 members have taught at two-year schools.
One might contend that the way to get the most bang from your buck in a prepaid tuition plan would be to attend the most expensive (and prestigious) four-year university in the state. That would be arguably the best course to take. But even if a student ends up at the least-expensive school, it would likely cost less to pay for his or her education in advance than to wait until the student matriculates before you deal with college bills.
If you have a comment or suggestion about this column, write to Boomer Bucks.