How to Pay for Private College Without Destroying Your Investment Portfolio

Despite little inflation in the rest of the economy, college tuition rates continue to rise, including those at private colleges, where 1 in 5 students study. According to the College Board, the average cost to attend a private university was 26 percent higher in the 2015-16 school year compared to a decade ago.

It's no wonder why many parents of young children today wonder how they'll be to afford the college of their children's dreams. One option for parents considering a private college or university is prepaid tuition plans, also known as Private College 529 Plans.

Available at 280 member colleges and universities in 39 states nationwide, Private College 529 Plans benefit from the same potential tax advantages that come with other 529 plans, as long as the money contributed is used to pay tuition and mandatory fees at a member school, according to the Private College 529 Plan website. (Tax benefits vary by state. Be sure to check with a tax professional.)

The plans differ from other 529 plans, which work much like a 401(k) or individual retirement account, investing contributions in mutual funds or other investments. Inasmuch, college savings in these plans are tied to the performance of the type of investment chosen. Traditional 529 plans can be purchased through an investment adviser or any large brokerage, such as Fidelity, Vanguard or T. Rowe Price, and are subject to fees associated with managing the account.

Private 529 plans, however, aren't an investment but are structured as a prepurchase of tuition -- think of them as akin to layaway for college. Tuition certificates are purchased for redemption at a later date. Money put into a private 529 plan today buys tuition at today's rates for redemption at some point in future -- as many as 30 years ahead. The savings are potentially huge, given the recent run-up in tuition rates. For example, if current tuition at your preferred school costs $30,000, then in 15 years, at a modest inflation rate of 3 percent annually, the cost would grow to $46,739. If you contributed $30,000 to a plan that guaranteed today's tuition, your tax-free savings at the end of 15 years would be $16,739.

The amount prepaid can cover up to five years of tuition at the most expensive school participating in the program (the contribution limit for 2015-16 is $256,000). The value of the certificate varies based on the tuition charged at participating colleges. A certificate worth one semester of tuition at University A may only be worth a 60 percent of a semester at College B. But the value stays fixed. A specific school doesn't have to chosen when enrolling in the plan, and the beneficiary of the plan can be changed to another family member.

The plans are geared toward parents who expect or prefer to send their children to private colleges, says Greg McBride, chief analyst at Bankrate.com. If the concern is being able to afford private-school tuition, private 529 plans may be the way to go, as the plans cover tuition and mandatory fees but not other expenses like room and board, he says.

That's an important consideration. As the College Board's latest findings showed, the average annual cost of attending a private university, including books, fees and living costs, topped $30,000 for the 2015-16 school year after factoring in grants awarded to more than 80 percent of private college students. (Without them, the bill soars to nearly $48,000.) One way to assure those costs are covered is to open a 529 plan along with a private 529 plan.

Another downside is that funds put into a private 529 plan can only be used at specific schools, and there's no guarantee that a student will be accepted at the college designated, although the funds can be rolled over to another institution. Also, private 529 plans are subject to penalties similar to other 529 plans. For example, if you don't use all of the money set aside for tuition, any remaining funds could be subject to a 10 percent penalty upon withdrawal.

Those looking to begin setting aside funds for future college tuition should carefully weigh their current financial situation. McBride warns that parents should put their retirement savings goals ahead of those for their kids' college tuition. While few like the idea of going into debt to fund a college education, McBride says, "You can borrow to put your kids through school, but you can't borrow your way through retirement."

David Schepp has spent more than two decades covering business news for the electronic and print media, including Dow Jones Newswires, BBC News Online, Gannett Co. and AOL's DailyFinance.