The future of pre-paid tuition plans

A piggy bank with the words "college fund" represents the costs of higher education.

TEXT OF INTERVIEW

TESS VIGELAND: A few years back we started hearing about a novel new way to pay for college: Pre-paid tuition. You picked a school, usually a state school, and paid as your kid got older. Presumably it would save your bank account from some of the outrageous inflation in college costs.

But like many a well-laid plan, this one is in trouble. Several states are abandoning the pre-paid programs or making big adjustments to them. And parents are wondering what happens next.

Jilian Mincer covered this recently for SmartMoney magazine. Thanks for joining us.

JILIAN MINCER: Thank you, it's good to be here.

VIGELAND: Talk to us a little bit about why these plans are in such trouble these days.

MINCER: It's an interesting thing. We have, unfortunately, the perfect storm with the pre-paid plans. Just as families really want the certainty of the plans, they're getting more expensive. And the way these pre-paid plans work is that someone would put what is generally more than the current tuition into the plan and then have the guarantee that the tuition will be covered x number of years down the road for their child or their grandchild or their niece or nephew. The problem is that as state budgets are facing incredible budget crisis, they are cutting spending on entire education. And as a result, the cost of the tuitions of higher education are soaring. They just doing keep up with the cost of higher education.

VIGELAND: So then why does that become a problem? Particularly, why is a problem right now? Say you have, you know, a two-year-old and you start putting into the plan for 16 years down the road. Why in the middle of that would you all of a sudden have a problem?

MINCER: It's a problem in that some states have committed to coughing up that cash x number of years from now. And a couple of states are actually getting sued over this. The Alabama plan closed a couple years ago, and it agreed last year to make up for that loss. But then it was sued by families who after running the numbers and looking at how quickly tuition costs were rising at the state's most popular institutions, that that wasn't even going to be enough.

Some experts in the field expect that instead of putting the pressure on the plans, they'll start putting the pressure on the universities. And by that, I mean, currently the states have used some estimates of what they think tuitions will go up, what they think the markets will do. And of course, that's been lower than we anticipated a few years ago. And they've come up with this formula, they expect in the future that instead, they're going to make agreements with the universities to accept whatever was earned during that time. And that's what Texas has done. It closed its plan in about 2004, 2005 and re-opened another plan. And the state universities have agreed to take those earnings. Of course, the problem with that is if the earnings are way low, then the burden is on the university system, and that university system may eventually go back to the state for more funding.

VIGELAND: So just to understand the math here, when the parents are making those payments, does that go into some sort of escrow account then, and it's invested?

MINCER: Typically, you'll pay more than what the tuition rate is now, but you won't pay what the tuition rate is expected to be, say, in 15 or 17 years, depending on your example. So for example, right now, in Washington state, tuition right now in the state is about $8,500. And for a future year of tuition, families are paying about $11,700.

VIGELAND: Hm. So at this point, would it be fair to predict that these plans are just gonna go away and parents of future college students should stay away from them?

MINCER: I don't think they'll necessarily go away. Many people who are experts in the field anticipate that more of the plans will look like the Texas plan. Parents will pay in now and the state universities will accept the tuition that the plans have earned at that point. They're still a really good tool for families to save in. The thing that families really need to look at is whether the state guarantees the plan, as it does in many states.

VIGELAND: Jilian Mincer is a senior investing report for SmartMoney and we've been talking about pre-paid college plans. Jilian, thanks so much.

MINCER: Thanks for having me.

VIGELAND: For some tips on making college more affordable, go to the Makin' Money blog, where Lynn O'Shaughnessy of CBS Marketwatch reviews four common myths about financial aid.

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