I have some 5th-grade students who are still small in stature and therefore have small hands. One of my students was having trouble creating sound on the instrument and, upon investigation, we found out it was because his fingers couldn't cover the holes all the way. So in my opinion, plugged holes are fine, I would just suggest gradually take the plugs out so they can better learn finger placement, as some would argue this takes away from proper finger placement. It would also do good to remember that not all students have the same shaped hands/fingers and may require a few plugs. As they grow up, you can hand them a step-up flute without plugs.
Really, you could toss this subject around for a while, but this is what I do with my beginners.