Prepaid College-Savings Plans Take Another Hit

By JILIAN MINCER

ZUMA Press

The University of Washington in Seattle: Legislators announced last week that the state's popular prepaid tuition 529 college-savings plan may be in need of an overhaul.

Even as college costs keep rising and recession-scarred families scramble for aid, several cash-strapped states have abandoned or scaled down one of the most popular college-savings options: prepaid tuition credits.

The next casualty may be Washington state, where legislators announced last week that the state's prepaid tuition 529 plan, called Guaranteed Education Tuition, may be in need of an overhaul. That comes on the heels of Tennessee's decision in November to shut down its prepaid plan, making it the eighth state to do so in the last few years. And in Alabama, legislators are facing a class-action suit brought by parents who say that state's plan is underfunded by $269 million, assuming tuition keeps climbing at its current pace.

As of now, only 11 states have plans that are still open to new investments, down from 18 in 2002, when the plans were at their peak.

That's bad news for a growing number of families who, still shaken by stock-market losses, have come to depend on prepaid plans. The plans allow families to purchase university credits at today's prices and use them at an indeterminate time in the future, typically for a public university in that state.

The plans work like annuity contracts, essentially allowing you to pay for up to four years of college at today's cost, though most plans now charge a premium. Washington's program, for instance, charges $11,700 for a year of future tuition, even though tuition at the University of Washington in Seattle will cost $8,592 this year. As in standard 529 plans, assets rise free of federal taxes—and often state taxes—if they are used for higher education.

Enrollment in Washington's prepaid plan was up 19% this school year. In Pennsylvania, where the plan is on solid footing, enrollment in the 529 Guaranteed Savings Plan rose 15.6%.

Investors with outstanding balances in states that have closed plans shouldn't worry, say experts. Plans have so far made good on their promises. "If you're already in the program, those terms will not change," says Betty Lochner, director of Washington's Guaranteed Education Tuition program. The $1.4 billion plan is solvent, she says, but legislators plan to study their options in preparation for a potential shortfall. The plan, which opened to investors in 1998, originally anticipated that tuition would rise 8.5% per year; instead, tuition jumped 13% in both the 2009-10 and 2010-11 school years. State officials expect costs to rise 11% in each of the next two school years.

Those who want to start investing in a plan should act quickly, since some states may soon close their plans to new investors, say experts. "Given where state budgets are, if something were to happen to the prepaid plan, states are not going to be in a position to put resources into helping them," says Jackie Williams, director of the college-savings initiative at the New America Foundation, a nonprofit policy institute in Washington, D.C. She was executive director of the Ohio Tuition Trust Authority, which, like Kentucky and West Virginia, closed its prepaid plan to new families after the dot-com bubble burst.

When considering your state's prepaid tuition plan, it is important to read the fine print, says Andrea Feirstein, a consultant to states and public 529 plans. Some states aren't obligated to bail out the programs if they fall into the red. As it is, Ms. Feirstein says, prepaid plans "are a good value only if you think your child will attend an in-state school."

Others aren't even sure that's a good idea. Tim Utecht, chief investment officer at Life Planning Partners, a financial advisory firm in Jacksonville, Fla., says his firm stopped recommending the Florida prepaid plan to clients after it raised costs this year to reflect an anticipated increase in tuition. "The prepaid plan was more attractive five, six, seven years ago," he says.

Families in states without a prepaid plan might consider the Tuition Plan Consortium, a national group of private universities that sponsors the Private College 529. It allows families to purchase tuition certificates, which can be redeemed for tuition—even if it rises—at about 270 schools in the consortium.

Write to Jilian Mincer at jilian.mincer@dowjones.com