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Related topics: college costs, tuition, education, savings plans, Liz Weston

Do you dream about sending your toddler off to college someday, but worry about the spiraling cost of a college education? There's a solution: Prepaid tuition plans that promise to lock in tomorrow's college costs at today's prices.

Under such plans, families are allowed to purchase blocks of tuition that can be used later at one of the plan's covered schools. If tuition rises after you've purchased the blocks, it doesn't matter: A semester purchased now will still buy a semester's worth of tuition 10 or 15 or 20 years from now.

Prepaid plans still have their drawbacks. They're best-suited for novice or conservative investors, because those willing to take moderate risks probably will end up with more money for college by investing in a 529 college savings plan or other portfolio that invests in stocks.

And, despite being marketed as a "guaranteed" way to save for college, you may still fall short with a prepaid plan. Some plans let you save only for tuition, not room and board. More significantly, the plan itself could fail or close down. You would get your original investment back, but that might not be enough to cover college costs. More on this risk later.

Image: Liz Weston

Liz Weston

But with the cost of tuition rising faster than the rate of inflation, you should at least explore prepaid plans before deciding on a college-savings strategy.

"Prepaid plans are good for families who want to pay for it and forget about it," said Joseph Hurley, a CPA who runs the Savingforcollege.com website.

How the plans work

Prepaid tuition plans are cousins to the more popular, state-run college savings plans. Both are known as 529 plans, after the IRS code that allows them. Like other college savings plans, prepaid tuition programs allow you to save for school in a tax-deferred investment. Withdrawals are tax-free when used for qualified higher-education expenses.

Both types of accounts get favorable treatment for financial aid purposes. They're considered the asset of the parent, rather than the student, which minimizes their effect on need-based aid.

But whereas college savings plans require you to take all the investment risk -- much like a 401k retirement plan does -- prepaid plans are designed to take the investment risk off your shoulders (rather like a traditional pension).

"A family that does not want to take on market risk with stocks and bonds may prefer the relative safety of a prepaid plan," Hurley said. Prepaid plans are typically a better bet than the low-rate, "guaranteed" options in college savings plans, which "may not offer much hope of keeping up with tuition."

Prepaid plans tend to work better for families with younger children than those whose kids are already in high school. Grandparents and others can contribute, too.

"Many programs charge a premium over current tuition," Hurley said, "and you need time to recoup the premium through tuition increases."

State-school vs. private-school plans

In the state-run plans, the blocks typically can be used at any of the state's public colleges and universities. The price of the blocks is based on a weighted average of current tuition at those schools.