When today’s college freshmen were born in 1998, a year of in-state tuition at the University of Virginia cost less than $5,000. Now it’s nearly $13,000. That’s a worrying prospect for the parents of a newborn. It’s hard enough to save for college. It’s even harder when you don’t know how much you’ll need to save.
12 states let you pay college tuition years in advance. But it’s not always a good idea.
Libby Nelson was Vox’s editorial director, politics and policy, leading coverage of how government action and inaction shape American life. Libby has more than a decade of policy journalism experience, including at Inside Higher Ed and Politico. She joined Vox in 2014.
But in 12 states (including Virginia) and at some private colleges, there’s a comforting way out: college savings plans that let you prepay tuition years in advance. The plans’ specifics vary, but they all let you pay tuition at today’s prices, then cash it in for college credits years in the future.
So if you’re averse to the risks of investing, this can seem like a solid option. It’s particularly appealing if you’re expecting or hoping that your child will go to a public university in a particular state. If you’re a die-hard University of Michigan alum planning on raising the fourth generation of Wolverines, buying into the state’s prepaid plan might not be a bad idea.
But prepaid tuition plans also have some big downsides that mean that, for most people, they should at the very least not be the only vehicle they use to save for college. If you’re considering one, here are four key questions to ask yourself.
1) Are you likely to send your child to an in-state school?
The University of Florida offers a prepaid tuition program.
Only 12 states still let you enroll in prepaid tuition plans: Florida, Illinois, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Tennessee, Virginia, Texas, and Washington. In all but Massachusetts, either the person opening the account or the child who will benefit, and sometimes both, has to be a resident of the state where the plan is run. A group of more than 250 private colleges also offer a prepaid tuition plan.
The most obvious thing to consider when looking at a state-based plan is whether you think there’s a good chance that your child actually will use the prepaid tuition by attending a public college in your state. That’s a hard call to make when you’re talking about toddlers or even newborns, but it’s worth at least thinking through how you’d guide your child’s college search, and consider the quality of the public universities in your own state.
Massachusetts is the exception — its plan includes many private universities too, including Amherst, Boston University, and Smith, although not MIT or Harvard.
But because a baby with a prepaid tuition account will eventually turn into a high school graduate with a mind of her own, it’s important to understand your options if she ends up going to college somewhere else. Most plans will give you the average tuition for in-state universities. If you live in Michigan and bought four years of tuition there, but your child decides to rebel and go to Ohio State, you’d have the average in-state tuition at a Michigan public university to spend for each year of college.
2) How fast is tuition going up in your state?
Prepaid tuition plans are technically a type of 529 plan, the state-run savings plans that let parents and families invest and save for college (click here for Vox’s in-depth story on 529 savings plans). Instead of investing your own money and withdrawing the principal and earnings tax-free to pay college expenses, you’re giving your money to the state prepaid plan in exchange for, essentially, tuition vouchers for a college in the state.
The “earnings” — the difference between the value of your tuition when you bought it and the value of the voucher you get later — aren’t taxed.
A good analogy, said Andrea Feirstein, the founder of AKF Consulting, a firm focusing on 529 plans, is that an ordinary college investment account is like a 401(k) plan: You put money in now and later you get back the original investment plus whatever additional money your investments earned. On the other hand, a prepaid tuition plan is more like a defined benefit pension — you’re guaranteed the same amount of benefits (a certain amount of college credits) no matter what happens to the markets in the intervening years.
If a student whose tuition has been prepaid decides to go to college somewhere else, or gets a scholarship, the money can be refunded. In most cases, a student who decides to attend another college gets the face value of his tuition voucher — that is, a year of in-state tuition.
The big question, then, is whether rising tuition is likely to produce a higher “rate of return” than investing in conventional assets like stocks or bonds. For example, if you bought a year of tuition in Virginia for a newborn in 1997, that turned out to be a pretty good deal: Over the next 18 years, tuition and required fees went from $4,648 to $12,998. That’s a rate of return of 5.8 percent per year, a little bit below the 7 percent that most investing advice assumes you’d get from the stock market, but with much less risk.
On the other hand, if you lived in Maryland and bought into that state’s plan, you prepaid about the same amount — $4,460 for a year of tuition and mandatory fees. By the time that newborn was old enough to attend college, tuition was $9,426. That’s a return of only 4.2 percent.
Tuition prices are dependent, in part, on how much the state legislature wants to subsidize higher education. So it can be very difficult to predict what’s going to happen in the next 18 years of state politics.
Still, it’s worth looking at how quickly tuition has been going up in your state and paying attention to the political rhetoric from both parties, particularly when the state budget is squeezed. Are legislators going to cut funding, forcing universities to cut back or increase tuition, the next time there’s a recession?
You can also look up what share of the costs students and families are already paying at public research universities in your state through the Delta Cost Project, which has historical data from 2007 to 2012.
In Pennsylvania, for example, students and families are already paying, on average, 77 percent of the total cost of their education at public research universities, while the state shoulders just 23 percent. That means that state cuts are unlikely to lead to unpredictable, big tuition spikes, because families are already paying so much of the cost.
On the other hand, in Tennessee, students are paying only about half of the cost of their education at public universities. This means a legislature determined to cut back state support for higher education could lead to big tuition spikes.
3) How strongly does the state guarantee the fund?
Massachusetts guarantees its plan with the full faith and credit of the state.
Prepaid tuition might seem like an ironclad guarantee: money upfront, tuition later. But states actually guarantee their funds at different levels, and it’s crucial to understand what’s backing up the promise of a tuition voucher, Feirstein said.
Only three plans — Massachusetts, Mississippi, and Washington — are backed by the full faith and credit of the state. That means you’ll only lose your money if the state as a whole defaults on its debts, something that no state has done since 1933.
The other plans don’t have such an ironclad guarantee. They’re backed either by the assets in the fund itself or by a promise that the legislature will budget the money needed to pay out the benefits. That can leave prepaid tuition purchases vulnerable if the state’s investments don’t perform, or if they’re forced to make big payouts as tuition goes up rapidly.
That’s exactly what happened in Alabama, where the plan was guaranteed only by assets within the fund. Tuition increased, and the state’s prepaid fund wasn’t earning enough from its investments to keep up. The plan stopped enrolling new participants in 2008. The legislature provided a bailout of nearly half a billion dollars, but that wasn’t enough.
Families who bought prepaid tuition and whose children are now starting college are only getting the value of tuition in 2010, when a year at the University of Alabama was $7,000. It’s now $10,170.
4) How are you paying for room and board?
Tuition isn’t always the most expensive part of going to college at an in-state public university. It’s everything else — transportation, books, room and board on or off campus — that really drives up the price.
The average published price of tuition and fees at a public university is $9,410, according to the College Board. Room and board adds another $10,140.
There are cheaper options than living and eating on campus. Still, prepaid tuition plans don’t cover those expenses, which can add up to tens of thousands of dollars over four years. That’s why Feirstein recommends supplementing a prepaid plan with a 529 investment plan, which can also include some extra money for if your child doesn’t finish in four years.
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