Mar 26

Mar 26 Betting on State: Prepaying for College

18 years ago, the average cost of attending a public university for one year was $8,653. Today, that’s more than doubled, topping $20,000. Any parent writing checks to a university today is sure to look at that $8,653 figure with envy. But what if there was actually a way to pay yesterday’s rates for today’s education? Or today’s rates for tomorrow’s education? In 11 states, there actually is. But it’s a risky proposition.

Betting on State

We’ll use Florida as an example to explore how the system works. In Florida, parents pay into a fund each month based on their child’s age. Using a 3-year-old as an example, parents would pay $131.70 per month. In 2036, after 187 payments, a 4-year Bachelor’s degree would be fully paid for. Our trusty calculator tells us that amounts to $24,627.90 in payments. Not bad for a diploma more than a decade and a half away, especially when you consider that college tuition has been increasing at a rate of 7.4% per year. Most of us would be hard-pressed to find a savings account, bond, or even mutual fund with such a return. As such, the guaranteed “return” is one worthy of a second glance. But let’s look at the trade-offs.

The Opportunity Cost

The states participating in these plans aren’t fools. Yes, they have a vested interest in the economic impact of a highly educated state. But they also have a plan for making the numbers work. Its name? Interest. In the 16 years remaining on our hypothetical three-year-old’s prepayment plan, the stock market is likely to have some impressive runs (as well as its share of humbling moments.) History tells us that over time, the stock market averages roughly 7% per year when adjusted for inflation. Does that 7% number sound familiar?

States are basically doing what you could do with that same $132 per month: investing it and earning interest. The opportunity cost here is the gains you may be able to achieve on your own. If the future is especially prosperous, you could be better off investing your college funds. But if the future is hairy, the prepaid state plan has a benefit the markets can’t match: it’s guaranteed to cover a 4-year degree inclusive of tuition and fees.

The Risks

Of all the pros and cons one need weigh in deciding whether or not to join a prepaid state tuition plan is this one: how confident are you in your child’s interest in attending one of the state colleges that qualify? Or even more important, how confident are you that your child will attend college at all? Some states make accommodations for such scenarios. In Florida, a child who decides not to attend college at all can get a refund of what they paid for their plan, but not the interest the state surely accumulated along the way. After 18 years, that lost interest will be no small factor.

Unique Benefits

Among the interesting benefits that caught our eye: if you move from Florida but your child returns to the state for college, they’ll still qualify for in-state tuition. In many states, the difference between in-state and out-of-state tuition can be tens of thousands of dollars. Such a benefit is no small factor. Another one: if tution skyrockets in the future, the plan will cover the increases within the state. (If you take your funds elsewhere, though, no promises are made.)

The Bottom Line

So who is such a plan good for? Those who would otherwise stuff their funds into a low-yield savings account and who come from a long line of state school grads are great candidates for prepaid tuition programs. Unlike the stock market, you can’t lose your money; you merely risk earning less than you could otherwise. In states where funds transfer even if your child chooses to attend another college, the risk is even lower. But keep in mind: every decision comes with an opportunity cost. There’s no way of knowing exactly how your college savings could fare in another savings strategy.