Prepaid college plans get a closer look

NEW YORK – It’s become part of financial wizardry 101: Savvy parents invest in 529 college savings plans.

But as the market suffers a relentless pounding, some parents are considering an alternative that lets them lock in tuition costs at state universities.

Such finality may be tempting at a time when the stock market’s future looks so shaky. Since hitting record highs in October 2007, both the Dow Jones industrial average and the Standard & Poor’s 500 index have lost about half their value.

Now those parents with 529 savings plans are realizing there’s no sure-bet magic formula for saving for college.

Unlike 529 savings plans, prepaid plans liberate buyers from the market’s up and downs. Families simply pay a fixed price for tuition credits that can later be applied to any in-state, public school. It’s up to the plan administrator to invest the money to cover costs.

“To a lot of people, it seems like a good time to look into it, given all the uncertainty,” said Mary Morris, executive director of the Virginia College Savings Plan.

Citing growing demand, the group this week extended the enrollment period for the state’s prepaid plan. So far, administrators say sales are up nearly 15 percent from last year.

While enrollment for 529 savings plans is open year-round, prepaid plans can typically only be purchased during a period of a few months to allow administrators time to crunch numbers for cash reserves.

College savings options

Each state offers its own menu of tax-exempt 529 savings and prepaid plans.

In part because of the market’s strong performance in recent years until now, 529 savings plans are significantly more popular than prepaid plans.

Last year, there were 8.8 million 529 savings accounts, up from 560,000 in 2000, according to the College Savings Plans Network. The number of prepaid plans, meanwhile, jumped to 2.3 million, up from 1 million.

The 529 savings plans are funds that mix stocks, bonds and short-term investments or money market accounts.

Most states offer age-based options, which are designed to grow more conservative in their mix as the child nears enrollment age and lessen the risk of losses as the need for the money approaches.

That doesn’t mean age-based plans are immune to the market’s swings. For instance, plans offered by T. Rowe Price keep 40 percent of assets in equities for students just four years away from college. Another plan at Vanguard has 25 percent in stocks for a child of the same age.

If you don’t like your local options, you can buy into any state’s 529 savings plan. There are usually tax benefits to picking one from home, however.

With prepaid plans, pricing and terms vary depending on where you live, the child’s age, the type of school selected (community college or university) and the length of the payment plan.

In Virginia, for instance, a lump sum, four-year university contract for an infant costs about $45,000. The contract covers tuition for any of the state’s public universities.

Prepaid plans are usually limited to state residents.

Prepaid plan drawbacks

One factor to consider with prepaid plans is that prices can be as much as 10 to 20 percent higher than current tuition rates, said Joe Hurley, founder of SavingforCollege.com. That means you’re betting on whether you think the cost of tuition will rise well above the price you lock in.

Rules vary depending on the state, however; some plans allow buyers to carry the value of tuition credits to private or out-of-state schools.

Prepaid plans also only cover tuition and fees, while 529 savings plans can be used to pay for room and board, books and other college-related costs.

Given the market’s plunge in the past year, prepaid plans might also be feeling enormous pressure to meet payment obligations, said Mark Kantrowitz, publisher of FinAid.org, a Web site that tracks the college financial aid industry. Even if your tuition is already locked in, the plan is still relying on your investments to pay the guaranteed costs.

This could prompt some plans to close enrollment to new buyers in coming months, he said. The plans’ accounting rules generally require them to keep a certain level of cash on hand, but it’s a good idea to check if any guarantees are included in case the plan goes under.

Prepaid plans might also be hiking prices to ease cash flow problems amid the market downturn, Kantrowitz said.

Growing costs

College tuition has skyrocketed in recent years.

In just the current academic year, the average price for tuition and fees at four-year public colleges rose 6.4 percent to $6,585, according to the College Board. At private colleges, prices rose 5.9 percent, to $25,143.

It’s no wonder more parents are opting for both 529 savings and prepaid plans. Some parents might even think both are necessary to get by. Yet right now, neither may be options.

“There’s more interest (in prepaid plans), but it’s balanced by the financial difficulty families are facing,” Hurley said. “(Families’) ability to afford anything right now is limited.”