What you need to know about prepaid college-tuition plans

You pay in advance—often with a guarantee your funds will grow to meet future college costs—but there are requirements and limits.

  • By Cheryl Winokur Munk,
  • The Wall Street Journal
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For some families, paying college tuition in advance may be a viable—and money-saving—option.

Like 529 college-savings plans, prepaid-tuition plans offer tax-advantaged savings. But prepaid-tuition plans have a key difference. While the returns of a 529 savings plan are dependent on the ups and downs of the market, prepaid-tuition plans usually guarantee that you’ll build up enough funds to meet tuition costs when your child reaches college.

Here’s how it works, in most cases. You contribute a target amount to the plans—the cost of a semester, say, or even four years—based on a calculation that takes into account today’s rates. Then the plan operators promise that the amount of money in your account will grow to match college costs down the road, or they’ll make up the difference.

State-run options

There are currently 12 state-sponsored prepaid-tuition plans open to new enrollment, according to Savingforcollege.com, an information and resource site. There can be state residency requirements for account owners or beneficiaries and the plans are generally designed to pay for tuition at a certain in-state school or schools, though some of the plans allow the funds to be used elsewhere.

For students looking to cast a wider net, there is the Private College 529 Plan, a prepaid-tuition plan available for nearly 300 private colleges and universities nationwide, including the Massachusetts Institute of Technology, Princeton University and Stanford University.

And, crucially, benefits in prepaid plans can usually be transferred to another beneficiary or refunded if a student doesn’t use them.

To better understand what a plan could look like, here are some figures using last year’s open-enrollment data from the Florida prepaid college plan. The prices, which are not expected to change in the coming enrollment period, are according to the Florida prepaid plan website for a child born on Dec. 10 of this year whose family meets the state’s residency requirements.

The family could make 223 payments of $46.61 a month, or $10,394.03, for a one-year Florida University plan that can be used at any of its 12 state universities—and receive an estimated future benefit beginning in 2038 of $17,000. The family also could opt to pay a lump sum of $7,373.92 at the outset for that estimated benefit.

For a four-year Florida University plan covering the same number of state universities, the newborn’s family could make 223 payments of $186.28 a month, or $41,540.44, for an estimated benefit beginning in 2038 of $66,500. The family could also choose to plunk down a lump sum of $29,472.26 at the outset for the same expected benefit.

The basics

So, is a prepaid plan a good bet? There are some things to consider.

First, each prepaid-tuition plan has its own participation requirements, enrollment period, contribution amounts, tuition-package options and rules about where the funds can be used, among other things. Each state also has its own rules about whether there is a state-tax credit or deduction and whether, and by whom, the plans are guaranteed.

Still, there are things these plans have in common. For one, prepaid-tuition plans generally offer some of the same benefits as a 529 savings plan. There can be tax advantages, and if the parent is the account owner, the funds are treated as parent assets, which is more favorable for federal financial-aid purposes than assets held by the student.

However, prepaid-tuition plans have more constraints and won’t be the right fit for every family. Many of the plans have in-state residency requirements, meaning that states may impose limits on who can participate. Prepaid plans also can be stingier about what expenses are considered “qualified.” Some prepaid plans, for example, don’t cover room, board and other costs that are permitted use of funds in 529 savings plans.

Nonetheless, prepaid tuition-plans have their advantages. They are most attractive to families who know with reasonable certainty where their child will attend school, says Brian Boswell, president and founder of 529 Expert LLC in Malden, Mass., which provides consulting services on 529 plan construction, distribution and sales. He offers the example of multigeneration legacy parents whose child is likely to attend their alma mater.

Mr. Boswell also points to College Board data indicating that about three out of every four students attend an in-state school—making the idea of a savings plan tied to a state potentially attractive. And, of course, prepaid plans can be a good choice for families that have the assets to cover tuition up front, he says.

Another benefit is for families who are particularly reluctant to take chances on the market, since these plans are often backed by the state that sponsors them. By contrast, investments in a 529 savings plan are subject to market risk, though some states have started to offer a guaranteed savings option within such a plan, says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com.

Prepaid-tuition plans also are popular in the financial settlements of divorce decrees, Mr. Kantrowitz says. Although many states don’t require college support in the event of divorce, some families include it. Often, the college-support requirement is defined in terms of the future cost of public-college tuition and fees. “One or both of the ex-spouses can then discharge their obligation through contributions to a prepaid-tuition plan,” he says.

When trying to decide which plan type is right for them, families should start by checking what types of plans their state offers, says Jim DiUlio, chairman of the College Savings Plans Network, an affiliate of the National Association of State Treasurers that provides information about 529 savings plans and prepaid-tuition plans. From there, families can decide whether a prepaid-tuition plan, if available, makes sense by itself, or in conjunction with another plan.

Mr. Boswell, who also is a certified financial planner, says he rarely recommends a prepaid-tuition plan by itself because of the restrictions they carry. But he says that his research shows contributing to a prepaid-tuition plan alongside a 529 savings plan can improve the account holder’s overall risk-adjusted return.

“There’s no rule saying that you can’t do both,” Mr. DiUlio says. “It’s all about choices that families can make.”

Families can use Savingforcollege.com’s online tool to look into prepaid-tuition plan options and compare them to 529 savings plans. They can also use an online tool offered by the College Savings Plans Network to compare options.

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