Prepaid tuition plans - another option for college savers

  @Money January 8, 2014: 10:56 AM ET
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For the conservative investor, a prepaid tuition plan offers an alternative to 529 plans.

NEW YORK (Money Magazine)

Tax advantaged 529 savings accounts get the most dollars from parents, but there's another kind of 529 that conservative investors may find attractive: prepaid tuition plans.

Offering identical tax benefits, these plans allow you to buy future tuition credits at a fixed price, so that you eliminate the uncertainty of relying on investments that fluctuate in value to pay for college.

True, many prepaid plans ran into trouble over the past decade as tuition inflation outpaced states' investment gains. Ten plans shut down, and two ended up paying parents less than promised.

Yet the health of the 12 surviving plans open to new investors has improved dramatically due to the stock market's resurgence and in some cases the adoption of more realistic (read: less generous) pricing and refund policies. Are they a better bet for your family than traditional 529s? Answer these questions to find out.

Does the plan suit your child?

Investing makes the most sense if your child has a good chance of attending one of the plan's member colleges. Nine programs are limited to residents attending mostly in-state public schools.

Related: What's the best way for you to save for college?

Three -- Alaska, Massachusetts, and the Private College 529 -- accept residents of any state but limit tuition guarantees to, respectively, the University of Alaska; about 80 public and private Massachusetts schools (see the list at mefa.org); or 270 private colleges, including Amherst, Notre Dame, and Stanford (find the list at privatecollege529.com)

Related: Grow a bigger college fund

Is the plan financially strong?

Be wary of plans that owe more to parents than they can pay -- currently, Illinois, Michigan, and Washington, the College Plan Savings Network reports.

The strongest guarantees offered are either the "full faith and credit" of the state or backing by the participating schools. "Fund" and "legislative" guarantees are weak. In a crisis, for example, Maryland's fund is guaranteed only to ask the state legislature for help; the legislature is not guaranteed to give it. (Savingforcollege.com lists each plan's guarantee type.)

How much does the plan cost?

Is the cost of college crippling?

Some plans charge a premium over current tuition rates (Florida, Illinois, and Washington). Others let you lock in today's prices: Alaska, Massachusetts, Michigan, Nevada, Texas, and the Private 529.

Some plans also strip away part of your gains if your child doesn't attend a member school or you want a refund (penalties are harsher if you won't be using the money for college). Check the plan's website for its policy.

Related: How much will that college really cost?

For some parents, like Ken Weingarten, a fee-only planner in Lawrenceville, N.J., the peace of mind that comes with the tuition guarantee is worth the risks involved.

Weingarten put above 40% of his college saving in the Private College 529, figuring there was at least a 50% chance that one of his two children would attend a member school. "The best-case scenario is I keep up with tuition, the worst is I lose a little on this portion fo my portfolio," he says. "I can live with that." To top of page

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