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February 14, 2011 4:23 PM Prepaid Tuition: Good Deals Gone Bad

By Daniel Luzer

Prepaid college savings plans, an important college financing tool for many middle-class Americans, are hurting, yet again.

According to an article by Jilian Mincer in the Wall Street Journal:

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.

College savings plans, which essentially allow families to pay for their children’s future college tuition at today’s prices, were never terribly extensive. Only 18 states had such plans at their most popular stage, back in 2002. Only 11 states now have plans where families are still allowed to make new contributions.

Prepaid college savings plans worked like this: families put money into the savings plans and then the accounts accrue interest so that, by the time children are ready for college, the savings plan has more than covered tuition increases at state universities.

The trouble is that the economy tanked. This means that not only did the tuition accounts earn less money, everything eared less money. Because public universities are facing financial trouble now too (lower return on their investments, less money from their state legislatures) they’ve raised tuition.

So now those glorious prepaid tuition accounts can’t really cover the cost of college. While it would seem that eventually the accounts might become profitable again, in many cases states aren’t required to maintain the accounts if they’re experiencing financial problems. And now most of them are.

Daniel Luzer is the news editor at Governing Magazine and former web editor of the Washington Monthly. Find him on Twitter: @Daniel_Luzer