CollegeIllinois! — the state’s prepaid tuition plan — has closed and is no longer selling contracts. It’s the second time in recent years the program has been closed as it struggles to fill a $320 million gap between the money it has taken in on prepaid tuition contracts and the cost of the promised tuition.

The idea was to pay for tuition now, when your child is young, at reduced prices – buying one or more semesters of tuition at a discount. Then the contracts could be redeemed for tuition in the future. The program was supposed to invest the money wisely to keep up with the rate of college cost inflation.

Obviously, that didn’t happen!

Last year only around 450 contracts were sold – largely because few people believed the state would come through on that promise, given its huge budget issues.

Worst of all, the state does NOT guarantee the plan payouts; it only has a “moral obligation” to make good. The legislature would have to vote to appropriate money to make good on the contracts.

Or come up with a tuition “voucher” which state schools would be required to accept.

Right now, the plan has not announced how it will handle payouts for tuition contracts that mature this year – much less years down the road.

Other state plans have closed down – most notably the original Michigan plan, and more recently plans offered by the state of Washington and Tennessee. The Alabama plan shut down in 2009, during the financial crisis. And Virginia is in the midst of a restructuring, according to Brian Boswell at www.529Expert.com. He notes that each state is a unique situation, though it appears many of these prepaid tuition plans could not invest successfully to keep up with college cost inflation.

Some states guaranteed the tuition payments. Others with underfunded plans have distributed funds with a discount or allowed investors to roll over the money into other types of 529 College Savings plans. Illinois has yet to make a decision about the future of CollegeIllinois!

Importantly, the prepaid tuition plan shutdown does NOT impact BrightStart Savings – the state’s tax-free college savings investment plan. In that plan, the money you accumulate for college on a tax-free basis can be used in any school in any state and for any child in the family. There are no guarantees Bright Start will purchase tuition, since the results depend on your investment choices.

In fact, Bright Start and Bright Directions (the broker-sold version of the Illinois plan) just made changes to reduce fees for investors in those plans. You can track plan performance and do comparisons at www.SavingforCollege.com. While prepaid tuition plans may only be used for tuition at state schools in your state of residence, the investment-type 529 plans can be used for tuition and other expenses at any accredited college.

We will update this post as more information becomes available from the Illinois Student Assistance Corporation, which runs the plan.