By Jeff Brown
With all the financial issues to worry about, wouldn’t it be great if you could pay your children’s future college expenses at today’s prices?

In fact, you may be able to through a prepaid tuition plan that offers tax-free returns that keep pace as tuition increases.

But there are some risks as many of these plans are now running short of money. Instead, some families might be better off with straightforward investments like certificates of deposit (CDs).

Prepaid tuition plans are a type of Section 529 college savings plan offered by the state governments. Investment gains are tax free, so long as they are used for tuition and other approved college expenses.

All states have savings-style 529s that typically offer an assortment of mutual funds, which can rise or fall with the stock and bond markets.

Nineteen states also offer their residents prepaid tuition plans, and the Independent 529 Plan is open to anybody, anywhere across the U.S. In most plans, the investor buys “credits” or a contract, the value of which rises according to an index chosen by the investor and tied to tuition rates at state or public colleges. While terms can vary, most prepaid plans provide some level of protection against loss.  In most cases, the child can use the funds at any public or private school in the country, though the Independent 529 Plan covers only 274 participating colleges.

In many years, tuition hikes average 5 to 7 percent, sometimes creeping into double digits.  Especially today, with five-year CDs yielding a meager 2.34 percent, according to the BankingMyWay.com survey, that makes prepaid credits an appealing investment. 

A number of states have reported increased enrollment in prepaid plans. But there are also problems. A few states promise to use tax money to shore up their plans if necessary, but many rely solely on the holdings the stock and bond portfolios funded with investors’ money.

Six states -- Colorado, Kentucky, Ohio, South Carolina, Texas and West Virginia, have closed their plans to new investors because they worry that plan assets could fall short. And many states have warned they can’t fully guarantee that a semester’s worth of prepaid credits bought today will really pay for a semester’s costs years down the road.

Since plan payouts are spread over many years, a rebound in stocks and bonds may well save many of the plans that appear troubled today. But that’s not guaranteed. It’s also possible that a market recovery would produce better gains in the savings style 529s. Those plans have no limit on gains, while the prepaid plans won’t go up faster than tuition.

Unfortunately, no one knows how fast tuition will rise. Historically it has gone up at about double the inflation rate, suggesting prepaid plans could return 6 to 7 percent a year.

One popular strategy is to use the prepaid plan as just one part of a college-investment portfolio that might also include savings-style 529s and ordinary investments such as mutual funds.

Before investing, be sure to study a plan’s details, especially the risk disclosures. The best information source is Savingforcollege.com, which also provides links to the state sites.

If your state’s prepaid tuition plan looks risky, take a look at a safer alternative, CDs, which carry a federal guarantee against loss. Use the BankingMyWay.com shopping tool to find the best deal.

Discover Bank of Delaware (Stock Quote: DFS) offers a five-year CD paying 3.6 percent. Some firms, such as Bank of America (Stock Quote: BAC) offer “opt-up” and similar CDs allowing the investor to profit if rates go higher.

Be sure to check out the BankingMyWay.com College Savings calculator to see what exactly it will take to help pay for your child’s future.

— For more ways to save, spend, invest and borrow, visit MainStreet.com.