Plan Prepays College Tuition at a Discount

Ryan Graves is only 13 months old, but his mom figures that she’s got his college savings strategy whipped. Melanie Graves, 40, is planning to prepay her son’s tuition through a new program called the Independent 529 plan.

The plan -- the first ever national prepaid tuition offering -- allows Graves to buy college tuition “units” at a discount to today’s prices. Better yet, she gets a guarantee that if Ryan attends one of the 225 participating private colleges, the units bought today will pay the tab no matter how much school costs rise.

In other words, Ryan will go to school in 2020 at 2003 prices because, by buying into a prepaid plan, Graves shifts the risk of tuition cost inflation from her shoulders to the college. All the participating colleges agree to give full credit for tuition units, no matter when they’re used, in exchange for getting people such as Graves to pay upfront.

“I like the idea that the institutions are going to take on the investment risk rather than me,” said Graves, who is a finance officer at Southern Methodist University in Dallas.

The colleges even provide a discount to their normal tuition price for those who go for the prepaid offer. The discounts vary from college to college, but they never amount to less than a half-percent per year, said Doug Brown, chief executive of the Tuition Plan Consortium, an Albuquerque nonprofit organization that administers the program.

The average discount is about 1% per year. That discount compounds, so someone paying 12 years in advance would probably get about a 12% break on the college’s sticker price, Brown said.

The plans can be unsuitable for lower- and middle-income parents, or for those who plan on sending their kids to a state university.

But the biggest caveat for parents such as Graves is one of choice. If Ryan is unwilling or unable to go to one of the universities participating in the prepaid plan, the money his mother invested on his behalf will prove to be a sorry investment.

If he withdraws the money to go to a college or university that’s not in the plan, the only guarantee that Graves gets is that she’ll get back the amount she invested, plus or minus 2 percentage points annually. (If the plan’s investments prosper, participants get a small share of the profit; if they lose money, participants share in a portion of the loss.) In other words, a $50,000 investment in 2003 would net her between $35,000 and $70,000 some 17 years later -- not exactly a bargain.

Graves is willing to take that chance because both she and her husband graduated from SMU -- one of the plan participants -- and because the plan incorporates 224 other highly regarded private schools, including Notre Dame, Princeton, Carnegie Mellon and Vanderbilt.

“I felt that there are enough colleges in the plan that Ryan will be able to get accepted to at least one of them,” she said. “There’s always a risk that he won’t want to go to college at all, but, if that happens, I think my problems are going to be bigger than the return I got on my money.”

Graves would feel differently about the prepaid plan, she admits, if she wasn’t so sold on private colleges -- and so convinced that her infant son will eventually choose one. No state-run colleges or universities participate in the plan. Notably, private colleges are more than twice as costly as public colleges on average.

Graves also would be less enthused about the prepaid plan if she didn’t have the wherewithal to set aside the full cost of college in advance. Although the Independent 529 allows small purchases -- parents can contribute as little as $25 a month, buying just a piece of tuition costs over time -- those who aren’t fairly well-heeled may find that prepaid tuition plans have significant shortcomings.

For instance, prepaid plans are a bad option for lower and middle-income parents who may be banking on financial aid to help pay college bills. That’s because money contributed to a prepaid plan reduces the child’s eligibility for aid on a dollar-for-dollar basis.

By contrast, each dollar a parent sets aside in a traditional 529 college savings plan would reduce the child’s aid eligibility by only about 6 cents.

Brown, and sponsors of other prepaid plans, are lobbying to change this rule, so that prepaid plans can get the same treatment as ordinary college savings. But it’s unclear whether that lobbying effort will be successful.

Then, too, the only thing a prepaid plan does is ensure that the parent’s savings keep pace with college cost inflation, said Joe Hurley, president and founder of SavingforCollege.com, a Web site dedicated to prepaid tuition and other college savings plans.

“Hedging tuition increases, whatever they might be, is the appeal of these plans to the conservative investor,” Hurley notes. But parents could potentially earn a significantly better return than the 5% to 6% average college cost inflation rate, if they invested their money elsewhere, he said.

Yet for parents such as Graves, who have both the money to finance private college and faith that their kids will choose them, this new prepaid plan is worth a look. More information about the plan -- including the list of colleges participating -- can be found at www.independent529plan.org.

Times staff writer Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com.