Future Tuition at Today's Prices

Once the ugly duckling among college-savings accounts, prepaid-tuition plans grew up to be surprisingly attractive. During the 1990s bull market, stock investments delivered more glamorous returns than prepaid plans, which merely promised to pay for tomorrow's tuition at today's prices.

Then, when the average tuition and fees at four-year public colleges surged by 57% during the past five years, many prepaid plans produced double-digit returns and looked like great investments. But they weren't so great for the states that ran them. With stocks in the doldrums and interest rates low, states struggled to make high enough returns on their investments to cover future tuition obligations.

Rather than risk making up a shortfall from state funds, five of the 20 states with prepaid plans -- Colorado, New Mexico, Ohio, Texas and West Virginia -- closed their plans to new investors. Others charged new investors a premium of 5% to 20% on top of current tuition. Before the Ohio plan closed, says Jacqueline Williams, of the Ohio Tuition Trust Authority, it was forced to add such a high premium that "we suggested that people with kids over age 14 not buy it because it would take four years to recoup their investment."

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Now that the stock market is looking up and tuition increases have slowed, "plans are in better condition," says Williams, and Ohio hopes eventually to reopen its plan. If you're fortunate enough to have a prepaid account with terms that haven't changed, hang on to it. If you're thinking of investing in such a plan, look into a number of factors: Do you have to pay a premium over today's tuition? If so, how long would it take to earn back the premium if tuition increased at, say, 5% a year? Does the state offer any kind of guarantee if there's a future shortfall, or is there a chance you'll have to kick in additional funds? If your child chooses an out-of-state school, how much of your money would you get back?

Mari Adam, a financial planner in Boca Raton, Fla., bought prepaid plans for her two children. In 1996, Adam paid $5,666 for four years of tuition at a Florida institution for her son, who's now in fifth grade. Today the same plan would cost $11,314 for a child his age.

Nevertheless, Adam still recommends the prepaid plan to clients looking for a guaranteed investment with attractive tax benefits, such as an exemption from federal income taxes. And investors can combine the prepaid option with stock mutual funds in Florida's 529 college-savings plan. Says Adam, "The two plans complement one another."