Is My Prepaid College Tuition Plan at Risk?

With so many states facing steep budget shortfalls, a reader worries that his investment in the state's prepaid college tuition plan may be at risk. He has good reason for concern.

Q: My state is one of many in a budget crisis. Is the money we have invested in our state’s prepaid college tuition plan at risk?

A: These days, anger over underfunded state employee pension plans attracts all the media attention, but there’s a reason for parents who invest in prepaid state college tuition plans to be concerned too. State budget shortfalls, steep stock-market losses and soaring tuition costs have left many of these plans deeply underfunded, and there’s a risk that some states may be forced to renege on their promise to pay for “tomorrow’s tuition with today’s dollars.”

First, a quick primer on how prepaid plans work: Prepaid tuition plans are state-run college savings plans that guarantee investors will see their savings rise in value at the same rate as college tuition. So, for example, if two parents invest $7,600 — about the average cost for a year at a public university today – for one year of school for their 13-year-old child, tuition for the student’s first year of college will be paid in full no matter how much the cost of tuition increases over the next five years. (You can learn more about the advantages and disadvantages of prepaid plans here.)

Sounds like a great deal, right? It used to be, but over the last few years these plans have been hit by devastating a one-two punch: huge stock market losses suffered in the wake of the financial crisis and soaring tuition costs. On top of that, widespread unemployment has cut deeply into state revenues, leaving less money to fully fund these plans. Earlier this year, both states of Texas and Alabama had to scramble to rescue their prepaid tuition programs: Texas ultimately closed its state-insured Texas Guaranteed Tuition Plan to new investors, while Alabama fully funded its Prepaid Affordable College Tuition program with a $547.6 million bailout, despite the fact that plan is not government insured.

Rather than close their plans’ doors, or resort to bailouts, other states are imposing new fees and raising the value of “today’s tuition dollars.” Last month, the state of Florida boosted the price of a four-year public university plan for a newborn in 2010 to $45,367, up from $40,086 in 2009. The plan also introduced new fees. (If parents spread payments over five years, it will cost $856 a month, or about $100 more a month than last year.)

Still, there are a number of states that are under no legal obligation to bail out their plans, or to make payouts as agreed upon when investors originally enrolled. To see where you stand with your prepaid plan, check the fine print to determine if your state is legally required to make tuition payouts. If it’s not, consider saving in a contingency fund, such as a short-term savings account, so that the money will be there to cover any potential shortfall when your child is ready for college. Invest in an account that is not tied to education costs so that you can withdraw the cash without penalty in the event you don’t need the money for college.

HAVE A QUESTION FOR "ASK THE EXPERT"? Email Terri Cullen at tcullen@hcplive.com.