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Prepaid tuition plans gain in popularity

MarketWatch reports that prepaid tuition plans, a lesser-used option offered by many state-run 529 college-savings programs, are regaining some of their earlier popularity.

For years, families have preferred the savings type of 529 plan - named for the relevant section of the tax code - salting away after-tax dollars, investing them in mutual funds and other investments, and then taking the money out, tax-free, when the time comes to pay for school.

But as many of these accounts have been savaged by the market's plunge this year, families are now turning to the prepaid variety of 529....

Prepaid plans allow families to lock in current tuition rates by making an upfront cash payment in exchange for tuition contracts or credits tied to current rates. They can prepay either the full tuition bill or a portion of it, typically based on the average tuition costs in the state. States usually manage the money, and when a student finally enrolls, he won't have to pay more - no matter how much tuition costs have risen.

If investors buy only a portion, that same amount is credited toward future tuition bills. In general, the tuition guarantee applies only to state schools within that state, though you can use the money to pay for out-of-state schools. If a beneficiary elects not to attend a college covered by the plan, the investor can withdraw his contributions, usually with interest....

In most cases, the account holder or beneficiary must live in a state in order to invest in its prepaid plan. Two states - Massachusetts and Alabama - allow anyone to invest in their plans.

There is also one private-school plan...that is open to anyone: the Independent 529 Plan. It allows investors to lock in tuition at nearly 280 colleges, ranging from small liberal-arts schools such as Grinnell and Oberlin to larger universities such as Stanford, Princeton and Duke....

Now looks to be a particularly good time to lock in current prepaid rates, as most programs will likely boost prices for next year's enrollment, given state budget shortfalls, sagging endowments and a drop in charitable giving. While average tuition and fees at four-year public universities increased 6.4% for the 2008-2009 academic year, according to the College Board's latest annual report, some experts predict double-digit tuition increases at major public universities.

Not all states have prepaid plans. To find out if your state does, check here and here.

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