New York (CNN/Money) -
Saving for college has been an uphill battle over the past few years.
While the cost of college continues to climb, investment portfolios have dwindled. The average price of tuition and fees at four-year public schools rose 9.6 percent this academic year, the College Board reports. And the 529 college savings plans that were invested in stocks fell 16.5 percent in 2002, according to Morningstar.
One safe haven has been prepaid tuition programs. Such plans are offered in 20 states and allow participants to buy education contracts or units at today's prices to be used for tuition in the future, with earnings exempt from federal and sometimes state taxes.
Now, though, it seems prepaid programs have also been clobbered by the double whammy of rising tuition and sagging stock prices. Many are reporting "actuarial deficits" in the millions to tens of millions of dollars, meaning the plans' assets are currently less than future tuition obligations.
For families participating in such programs, there seems to be no danger of losing your college savings, but now more than ever it's important to understand exactly what each plan is promising and how states back that promise.
Why plans are in the red
Although prepaid plans are managed and, in most cases, guaranteed by the states, they are not immune to tuition increases at state schools. To make up the difference between what participants pay and the actual cost of tuition down the road, the plan administrators pool participants' money and invest it. When tuition and fees at state schools increase more than the plans had anticipated and investments fall short, they run actuarial deficits.
Ohio's Guaranteed Savings Fund, for example, has projected a market value deficit of $46.7 million, and Mississippi's prepaid program reported a $35.6 million projected deficit at the end of its last fiscal year, to name a few.
Plan administrators in most states say these projected shortfalls are irrelevant. "There is a major difference between having an actuarial deficit and a cash-flow issue," said Randy Erford, director of College Illinois!, the state's prepaid plan. His program reported an $18.6 million deficit in its last annual report, but funds are sufficient to pay all benefits through 2018 even if the program sold no more contracts, according to Erford.
"New participants will continue to join the program, current account holders will continue adding to their accounts, and program investments will have time to rebound," notes Betty Lochner, Director of Washington's Guaranteed Education Tuition program, which has projected a $21.6 million deficit.
Administrators in Colorado, however, where the prepaid plan is not guaranteed by the state, are not so optimistic. In August, they closed the plan to new enrollments and next month will stop accepting payments from existing contract holders. Participants who withdraw from the plan before February 20 will receive a refund for the amount they've contributed or today's average tuition, whichever is greater. After that date, refunds will be the lesser of the two. Participants can keep their money in the fund, of course, but unless the state's legislature agrees to back the fund's shortfalls, the tuition benefits will be capped at 5.5 percent a year. If tuition fees climb beyond that in any given year, plan participants will have to make up the difference on their own.
"Today's prices" have gone up
Other plans in trouble have not taken such drastic measures, but most have raised their prices -- in some cases by a lot, to account for rising tuition and weak investment returns.
As of January this year, tuition units in Ohio are $81.50, a $20 increase from the same time last year. (In Ohio, 100 units are generally equal to one year of in-state tuition.) Illinois' prices increased 23 percent for the 2002-2003 academic year. And in September, Washington raised the price of a unit from $42 to $52. Meanwhile, Nevada's state treasurer has said that the cost to enroll in his state's plan is likely to rise 30 to 50 percent this year.
According to Diana Cantor, chairman of the College Savings Plan Network and executive director of Virginia's prepaid program, the plans are reacting to tuition increases. They do not profit from higher prices.
"Tuition and fees at community colleges in my state went up 30 percent this year," said Cantor, referring to Virginia, where prepaid contracts will climb 25 percent for the enrollment period beginning in February.
What can you do?
If you've already purchased a tuition contract in which you've paid in full for future tuition or have signed up for an installment program, you can probably breathe a sigh of relief. "Rising prices generally affect future enrollees, not current enrollees," said Joseph Hurley, president and CEO of Savingforcollege.com.
You may not be so lucky if you are participating in a program that sells units instead. "In states that sell units, like Ohio, Pennsylvania and Tennessee, you don't own anything you haven't already paid for," said Cantor.
The fine print is more important than ever
If you're considering putting money in a prepaid plan, now more than ever it's important to pay attention to all the details. Every state's plan is different.
You'll want to consider the plan's flexibility. Prepaid plans were traditionally designed to pay for tuition at public schools within the state, but today most allow you to transfer the value of your contract to other states' schools and private schools.
Also, pay close attention to the plan's refund policy. Under the best refund policy, you'll get all of your money back, no strings attached, plus a little extra.
With College Illinois!, for example, you can cancel at any time, for any reason, for a $100 fee. If you cancel within three years of your purchase, you get all of your money back. After three years, you get all of your money plus 2 percent compound interest. And in Texas, if you cancel after the beneficiary turns 18 or graduates from high school, the refund amount is based on the current average tuition rate, which can be substantially higher than what you put in.
Look, too, at whether your state guarantees that the tuition contracts or units you purchase will be enough to cover future education costs. A handful of states back their prepaid programs with the full faith and credit of the state. Others have statutory guarantees whereby the legislature can appropriate funds to cover any shortcomings of the prepaid plan. But not every state has an official guarantee. Colorado currently has no guarantee behind its plan, which is why it's closing to new participants and facing a cap on tuition benefits.
As with any investment, you'll want to weigh the risks and the return. When the stock market had annual gains in the double digits and tuition was rising modestly, parents turned their noses up at prepaid plans. But over the past couple of years the effective rate of return for these plans has been better than just about any investment out there, and for little to no risk.
"When the market goes down the effects are magnified in the prepaid world because these are the times when there's less going to higher education and tuition increases," said Cantor. "But when the market recovers the reverse is often true as well."