Prepaid College Tuition Isn't for Everyone

Whether it's a good idea depends on the fine print.

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Dear Alpha Consumer,

My son has been accepted at an Ivy League school that offers a tuition prepayment plan. We have the money to pay in advance ($100,000 in a 529 and $47,000 in liquid assets), but I'm wondering if that's a good idea.

I figure that tuition rates increase at roughly 4 to 5 percent a year and that if we are not earning 4 to 5 percent a year on our money, then it's best to pay in advance.

Many colleges now offer tuition prepayment plans, which, as you describe, give parents and students the option of locking in tuition rates. But they also come with some risks, the biggest one being depleting a large amount of savings that could be earning a return if it were invested elsewhere.

The first step is to research the fine print of your particular college's plan, suggests Kevin Walker, president of Simple Tuition. What happens if the student withdraws or transfers? Are there any other penalties? What happens to the money if family circumstances change and the student becomes eligible for grants or financial aid? Since Ivy League schools often offer generous grant packages, "it might not take a catastrophic event to have the family go from [paying in full] to being heavily subsidized," Walker says.

Different colleges offer different answers to those questions. At the University of Southern California, any prepaid money that is unused because a student graduates early or leaves the university is refunded. At Dartmouth, the refund is made on a prorated basis, and the school reserves the right to deduct more money if it deems it necessary.

Paul Wrubel, cofounder of Tuition Coach, suggests avoiding the prepayment plan altogether, to prevent depleting so much in savings—especially if it is earning money through investments or interest. Parents, he warns, should keep their savings for retirement, since, unlike college, no loans or grants are available for financing those years.

Of course, everyone's financial situation is different, and if you also have sufficient funds tucked away for retirement, then the calculation will depend heavily on whether the money you have saved can earn more in interest than the expected rate of tuition inflation, as you suggest. It's impossible to predict with certainty, so only you can make that call.