Prepaid college tuition funds sound like a good thing. You pay now toward your child’s future tuition, you protect yourself against unpredictable tuition increases in the future, and you save on your income taxes. Sounds like a good way to provide for your child’s education, right?

Well, when in doubt, consult the experts. Financial planners help people with long-term financial goals like funding college for their kids. And surprisingly, we couldn’t find a single financial planner who thought prepaid plans were a good option for most parents.

What Are Prepaid Plans?
Prepaid college tuition plans are run by state governments (see sidebar for a list of states that offer these plans) and typically come in a couple of flavors. Some plans let you buy tuition "units" at a given price. Each of those units equals a certain percentage of a year’s tuition. Some plans sell you a contract for a certain number of years of tuition. Either way, once you have prepaid for these units or contracts, you can use them to pay for your child’s tuition when he or she enters college, no matter how much tuition has gone up in the meantime.

Since tuition rates are currently hurtling upward far faster than most investments, this can look like a pretty good deal. Prepaid plan contributions also look pretty attractive from a tax perspective – your contributions are exempt from federal income tax and often from state income tax as well.

The Major Drawbacks
The problem with prepaid plans is that they come with some pretty severe restrictions. Below are some of the biggest issues.

Not All Kids Go to College
No matter what parents might wish, not all kids will choose college or be able to meet admission requirements. “I had three children and planned for all to attend college,” says Gerald Weiss, a certified financial planner and specialist in college financial planning. "Two out of three did. No matter how much the parent wants the child to attend college, the child will eventually do what he or she wishes. Therefore, flexibility is of utmost importance in selecting a college savings plan.” In many cases, money locked into a prepaid plan is very difficult to extricate if your child doesn’t attend college.

Limited College Choices
Prepaid plans usually don’t cover tuition at just any college your child might choose to attend. They are limited to state schools. In states with diverse and plentiful state college options, this might not seem like such a severe restriction. However, many states do not offer prepaid plans, and in those that do, the state colleges may be limited in quality or quantity. Parents are often unwilling to place such tight boundaries on where their children eventually choose to attend school.

As well, you may not be living in the same state when it’s time for your child to go to school. “People move around a lot more than they used to, so knowing where you will be in 18 years is harder to predict than it used to be,” says Lauren Gadkowski, a certified financial planner in Boston, Mass.

Financial Aid Eligibility
Even if your child goes to college and picks a state institution that is eligible for the prepaid plan you invested in, there is still a major drawback. Prepaid plan savings can heavily impact your child’s ability to qualify for financial aid. “Prepaid contracts reduce the family’s financial need dollar for dollar, versus a 529 savings type plan which counts only 5.6 percent of the parents’ college savings account in the financial aid formula,” says Weiss.

This is an important consideration when you consider the total costs of attending college – tuition is far from the only expense. Weiss points out that in many states, prepaid plans cover only tuition and fees, which can be as little as half the total cost of attendance when you add room and board into the picture.

The Fine Print
As well as their major disadvantages, prepaid plans have several other characteristics in the details which many parents may find problematic.

• State Funded – Prepaid plans are run by state governments. “Issues with state budgets make people nervous about the ability of these plans to remain solvent when the economy is not so stable,” says Gadkowski. In her state of Massachusetts, the current budget disaster makes this a very real issue of concern and is one of the main reasons she hasn’t recommended many prepaid plans to her clients.
• State Residency Required – Many state prepaid plans have requirements about residency, either of the parents or the student. Plans generally require that you are a state resident when you open the plan – you usually can’t buy a plan in a state with a really good state college system unless you live there. As well, if you have a prepaid plan in a certain state, but no longer live in that state when your child attends college, your child may not qualify for in-state tuition rates, but the prepaid plan may only cover in-state tuition. In this case, you would be responsible for the difference between in-state and out-of-state tuition.
• Time limits – Prepaid plans often come with an expiration date. “Most prepaid contracts have time limits,” says Weiss. “Typically the contract is terminated if benefits are not used within 10 years after the beneficiary’s normal college start date.” In other words, if your children are late bloomers or don’t do all four years of college at once, you may lose some or all of the money you have put away for their education.

Why Do These Plans Exist?
One might ask, with all the limitations and drawbacks, why prepaid college tuition plans even exist. One reason is that their advantages and disadvantages change over time. In the past, when people tended to move around less and children often went to college locally, these plans served an important need. In the future, financial aid rules may change so that these plans aren’t such a huge disadvantage in qualifying for financial aid, and institutions other than state schools may begin offering prepaid plans. While prepaid plans don’t seem a good choice for most parents right now, that answer may change in the future.

In addition, despite all the limitations, some people still choose prepaid plans as a way to fund their child’s education. If you are the third generation alumnus at your state’s flagship college and are sure your son or daughter will follow in your footsteps, a prepaid plan might be a good option.

If funding college will be a substantial challenge for you and you are pretty sure your child will attend the local state college and live at home, a prepaid plan might again be a good option. Just be very sure you read the fine print, understand the limitations of your state’s plan and perhaps consult an expert before you sign on the dotted line.

Want to see more?

• Financing College: When to Start
• The Financial Aid Puzzle: Avoiding Financial Aid Foibles
• Financing College: Where to Put Those Hard-Earned Bucks
• Achieving Your College-Savings Goals: Understanding the Keys to Success
• Talk about it!