Prepaid Tuition Rarely the Best Choice

At least one tuition savings plan guarantees enough money to cover costs.

Many colleges let parents prepay the tuition, locking in tomorrow's education at today's costs.

But if maximizing returns on college savings is your focus, many financial advisers recommend looking elsewhere.

"Certainly, in the last couple of years, you could have done better investing in a good solid mutual fund," says Ray Loewe, president of College Money, a financial-planning firm in Marlton, N.J.

Still, the idea appeals to plenty of people.

Michigan launched the first prepaid plan in 1988. Now, 20 states offer such programs, and that number is expected to double by 1999, according to the College Savings Plan Network, an association of state programs.

The plans picked up steam in the early 1990s as tuition inflation peaked in the double digits for public universities. Since then, cost increases have stabilized, causing financial advisers to question the value of prepayment plans.

Specifics vary by state, but the concept is to prepay tuition either in a lump sum or through an extended monthly payment plan. The state pools the money and invests it.

When the participant enrolls in college, a payout is made to the school of choice. If the student chooses a public university in another state or a private college, the payout is generally portable. But it may not cover their often-higher costs. All the plans offer refunds, minus a penalty, if the child does not attend college at all.

Federal taxes on the gains are deferred until the money is used for tuition, and then it is paid at the student's lower tax rate. (But note that for the new individual retirement accounts, the education IRA and Roth IRA, there's no federal tax at all on gains.) Many prepayment plans are state-tax exempt.

The plans aren't for everyone, but they may help "people who aren't saving otherwise," says Barbara Jennings, director of the Ohio program.

"We're not selling an investment; we're selling a guaranteed contract," says Marshall Bennett, state treasurer of Mississippi and chairman of the College Savings Plan Network. "For the unsophisticated investor who doesn't know how to play the stock market ... this is a perfect, no-risk way to do it."

"But a guarantee doesn't mean it's a reasonable and good deal," says Doug McDaniel, a financial adviser in Jackson, Miss., who looked into the plan for his three young children.

"For me, it was an absolute no-brainer that it makes more sense to invest the money in a conservative investment with some stock and bond exposure," he says. "I suspect my rate of return will be double."

Mr. McDaniel sees one scenario where prepaid plans are attractive: when you have a high-schooler who plans to attend a state university. If you've already saved a lump sum, using it to prepay tuition exempts you from further cost increases.

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