It's a deal that seems difficult to turn down. If you're a numbers person you likely understand that inflation decreases the value of your money every year. The U.S. Bureau of Labor and Statistics reported the annual inflation rate was 2.9% for the 12 month period ending January 2012. This meant that if you had $10,000 in the bank during that period and you were fortunate to get a 1% interest rate, by the first day of 2012, it only had $9,807 of buying power (in theory).
That hurts, but if you're responsible for paying college tuition for your children, there's another type of inflation. According to FinAid.org, college tuition inflation averages around 6% each year making your $10,000 savings worth only $9,400 to a college next year.
According to Savingforcollege.com, if you have a four-year-old child who attends a school that costs $25,000 annually, you'll need to save $247,265 to meet 100% of his or her college costs 14 years from now. That's $698 per month that you'll need to save.
For most Americans, saving this much per month for college expenses along with assuming that those funds will grow 7% annually isn't realistic. For this reason, each state created college savings plans that would help families save for their rising college tuition costs.
The Prepaid Plans
Looking at future college costs is sobering. If you could avoid 14 years of college inflation by paying for most or all of your child's tuition at today's rates, that makes it an offer hard to turn down. Currently, 19 states offer prepaid plans, but 10 states no longer accept new participants. Prepaid plans, much like corporate pensions, are quickly dying and for good reason.
The economy isn't what it was when these plans were created. Ultra safe investments yielding results that beat the standard rate of inflation are much harder to find, and many states have seen revenue dry up making it increasingly difficult to balance their budgets. Currently, prepaid plans are 93% funded, but states like Kentucky, Illinois and South Carolina are less than 80% funded making changes to these plans likely. Alabama faced the same problem and now pays less than the cost of full tuition.
Should You Invest?
In most cases, in order to participate in a prepaid college plan, you have to be a resident of the offering state. Second, if your child is planning to go to an out of state or private school, don't expect full payment. Prepaid plans only guarantee to pay for an in-state, public university, reports FinAid.org.
In Florida, the largest prepaid college program in the country, your same four-year-old child as above would cost $346 per month to fund his or her four-year education when he or she reaches the age of 18.
Financial advisors aren't quite as convinced. Concerns over the future of these plans make your investments not without risk. Three states, Massachusetts, Mississippi and Washington guarantee their plans with "the full faith and credit of the state," but the other plans have no such guarantee making them susceptible to future economic headwinds.
Although no plan has ever returned less money than a person put in, not having enough for future college costs is still a possibility. Some advisors believe that traditional 529 investment accounts are a better choice than prepaid plans.
The Bottom Line
Although only 10 states offer prepaid plans, the potential savings that comes with prepaying tuition costs at today's rates makes these plans attractive to those who can afford the payments, but some believe they may be too good to be true. Because of that, investing in other tax advantaged plans for college savings have to be considered along with the prepaid plans.
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