Saving for future in-state public university tuition and fees is tough, but it's even harder to save for private colleges. The average tuition at a private college for the 2012-2013 school year was more than $29,000, according to the College Board – more than three times the average in-state tuition of four-year public schools and 4 percent more than the previous year.
If this rate of increase continues, parents of an 8-year-old could spend nearly $44,000 per year for college tuition 10 years from now.
In order to hedge against rising private college tuition by saving for college in a 529 plan, a tax-advantaged investment account, parents have two options: save for tuition in a private college prepaid plan or a state prepaid plan.
[Learn if a prepaid college tuition plan is right for you.]
Prepaid plans guarantee future tuition rates at today's prices, while in a traditional 529 plan the money in the account increases based on investment growth.
Families can lock in current tuition rates at one of more than 270 private colleges across the country with a private college prepaid plan.
"Families contribute to a trust and get a certificate representing a share of tuition at current rates, a proportion that remains constant even as tuition rises," says Nancy Farmer, president and CEO of The Private College 529 Plan, a private college savings plan.
"So, for instance, if you were to pay in $10,000, and the tuition at a given college were $40,000, the certificate you bought would be worth a quarter of one year's tuition at that college," she says. "If, in 10 years, the tuition is $60,000, your certificate would be worth a fourth of that amount, or $15,000. Money must be in the plan for a three-year vesting period before it can be used."
If a family bought a full year's tuition at 2002-2003's Princeton University tuition price of $27,230, the certificate could be redeemed for tuition for the 2013-2014 school year at $40,170, Farmer says. The value increased by nearly 50 percent or about $13,000.
If the parent puts in about the same amount of $26,266 and the student decides to go to Occidental College, where the 2013-2014 tuition is $45,190, the credit would be worth about 72 percent – nearly $19,000 – more than the original investment, she says. A $10,000 investment would have also been worth $2,000 more at Occidental because tuition was more expensive.
[Find out a college's true cost with a net price calculator.]
Certificates can end up worth more if purchased in June than July. For example, if parents buy tuition certificates this month, they're buying tuition at the 2012-2013 cost to be used whenever the student attends school in the future at that year's rates, Farmer says.
Since tuition will likely rise in July for 2013-2014, there will be a smaller difference between the cost of tuition in the 2013-2014 school year and when the student uses the funds. Credits work at any of the colleges that participate in the plan, so it doesn't matter which of those schools a student picks, she says.
However, it does matter if a student chooses to go to a state school. "If you are the fourth generation to attend the University of Michigan and you are absolutely certain that is where your future student will enroll – Private College 529 Plan is not for you," Farmer says.
If a student decides later to attend a public school, the money can be withdrawn from a private plan with no more than a 2 percent increase or decrease in initial value, she says.
The alternative is to choose a state prepaid plan where parents buy tuition credits that are generally redeemed at a future year's public in-state tuition rate.
[Get the truth behind these prepaid tuition plan myths.]
"For example, if a child attends in-state at the University of Nevada—Las Vegas, the program pays $191.50 per credit hour. That same rate would be paid to BYU if a beneficiary attended that college," says Sheila Salehian, senior deputy treasurer of southern Nevada, referring to the private Brigham Young University. "Depending on the tuition rate, it may be paid in full or the beneficiary will have to make up the difference."