Prepaid tuition plans allow parents, grandparents and others to prepay future tuition at eligible public and private colleges or universities at today’s tuition rates. Locking in today’s prices may sound like a good idea, but there can be drawbacks. Here are some things to consider:
Contribution Limits
You pay for amounts of tuition (years, credits or units) in one lump sum or through installment payments. There are a number of options. Some prepaid tuition plans offer contracts for a two-year community college or a four-year undergraduate program, or a combination of the two, and can cover one to five years of tuition. Some plans even allow the contract to be applied to graduate school tuition.
Covered Educational Expenses
With only a few exceptions, however, most prepaid tuition plans do not cover other expenses, such as room and board. So you may want to consider other college savings options to cover these costs.
Guarantees and Safety Features
Most states guarantee that the funds you put into a prepaid plan will keep pace with tuition. Some states back their prepaid tuition plans by the full faith and credit of the state, meaning that if the program should find itself in financial difficulty, the state will step in to provide the necessary funding. Other states do not have a formal guarantee, but do have a formal process by which the state’s legislature will consider making an appropriation if necessary. Some states offer no guarantees that the plan will fund the future cost of tuition or that the state will step in should the plan falter.
Residency Requirements and Other Limitations
Unlike college savings plans, most state prepaid tuition plans require either you or your child to be a resident of the state offering the plan when you apply. Some limit enrollment to a certain period each year. Many prepaid tuition plans also have age or grade limits for beneficiaries.
Investment Options
Prepaid tuition plans have no investment options. Under prepaid plans, the price of the contract is determined prior to purchase and usually depends on the type of contract, the current grade of the student, the current and projected cost of tuition and the projected rate of return. These programs then pool the money and make long-range investments so that the earnings meet or exceed college tuition increases. When a child is ready to go to college, the plan transfers funds to cover the tuition directly to the institution.
Portability
If your child chooses not to attend a college covered by the prepaid tuition plan, all is not lost. Although you will not get the benefit of guaranteed tuition, all prepaid tuition plans allow you to use plan money to pay tuition at other colleges and universities. Many state prepaid tuition plans will pay out an amount equal to the weighted average tuition and mandatory fees at your state’s public institutions, not to exceed the actual tuition and fees you incur. Most plans also let you transfer the prepaid tuition to a child’s brother or sister (although age restrictions may prevent transfers to an older sibling). Unfortunately, if your child chooses not to go to college and a sibling doesn’t use the plan, or you need to cancel the contract, most plans will only give you back what you originally contributed with a reduction or elimination of any interest earned. Some plans also charge a cancellation fee.