What does the future hold for prepaid tuition plans?

http://www.savingforcollege.com/articles/what-does-the-future-hold-for-prepaid-529-plans-1003

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Most press coverage and even our own here at Savingforcollege.com focuses on the "savings" variety of 529 plan. But what of the prepaid tuition plans, particularly state-sponsored prepaid tuition plans? Why is so little attention devoted to them? What has happened, and are they still a viable option for college planning when it seems even the most successful prepaid tuition plans encounter headwinds in their operations?

These questions are not new, but the recent report that Virginia529 prePAID may consider changing its structure to limit new participants to in-state schools again highlights the challenges of administering a prepaid tuition plan. There are only 19 prepaid tuition plans compared with over 80 savings plans, and of those only 11 prepaid tuition plans are still available to new investors.

Prepaid tuition plans have similar challenges to pension plans, where it becomes more difficult to meet obligations during a severe market downturn, such as in 2001 and 2002, and again following 2008. Four plans closed to new enrollments in 2003 alone of the 20+ plans available at the time (some of which were already closed). There were fewer issues following the 2008 recession, since plans had worked out most of their kinks in the prior downturn. Even still, Alabama suspended enrollment in its PACT plan in 2009, and it remains closed even today. Tennessee, South Carolina, West Virginia and Washington all reported serious difficulty with funding at the time.

For these and for other practical reasons, there are greater restrictions on prepaid tuition plans to limit enrollment and create predictable revenues and costs. For example:

• Most prepaid tuition plans have state residency restrictions for participants
• Plans may limit the choice of school to one that is either in-state or within in its partnership system
• There can be severe earnings penalties if the account owner converts the plan for use with a plan outside their network
• Expenses covered are more limited than a savings plan, covering only tuition or tuition and some fees, for example.

RELATED: Prepaid tuition plans: Here's what you need to know

A timeline of prepaid tuition plan challenges

2001
» New Jersey enacts a bill to add a prepaid tuition plan (not launched)

2002
» Wisconsin's EdVest program suspends its Tuition Units option

2003
» Kentucky, Ohio, Texas, and West Virginia all suspend enrollments in their plans
» Mississippi is reportedly running a severe deficit for its plan

2005
» Pennsylvania hires Moody's to evaluate and restore confidence in its prepaid tuition plan, eventually garnering an A3 rating

2006
» Pennsylvania removes premium on tuition credits for its plan and switches administrator to Upromise (now Ascensus)
» Ohio adds significant restrictions to its Guaranteed Savings Fund in an effort to reduce its plan deficit
» Alabama suspends enrollment in its prepaid tuition plan

2009
» Pennsylvania imposes additional fees in order to remain financially solvent
» Tennessee, South Carolina, West Virginia and Washington all report financial challenges

2010
» Alabama PACT proposes to remove tuition guarantee due to severe fiscal issues. The state also passes a bill to help bail out the program
» The Independent 529 Plan stops offering a discount from tuition with participating colleges
» Tennessee suspends enrollment in its prepaid plan

2011
» An outstanding suit against Alabama's PACT plan is ruled to proceed as class action for all 42,000 participants, and settles later in the year.

2012
» Mississippi suspends enrollment in its prepaid tuition plan

2013
» Court rules in favor of Alabama PACT that the plan can make reduced payouts even to participants that entered the plan prior to the legislation that allowed the reductions
» Colorado Prepaid Tuition fund is terminated

2014
» Mississippi MPACT plan reopens

2015
» Washington suspends enrollment in its prepaid tuition plan
» Tennessee's BEST plan is terminated

This list is by no means comprehensive. And with so many challenges, what does the future hold?

There are successful prepaid tuition plans. Those that have remained particularly stable are able to do so by distributing the risk among the stakeholders, meaning the state, plan, and higher education institutions all bear some of the risk of tuition rates outstripping plan funding. There is one non-state-sponsored 529 plan: a consortium of private colleges, located across the country, operating a prepaid tuition plan. The Private College 529 Plan member schools contractually guarantee tuition pre-purchased by account owners, so the plan completely disseminates funding risk to its participating schools.

States that have tighter control over the tuition of their schools have, in some cases, limited tuition increases for participants in their prepaid tuition plan. This alone significantly reduces the burden on the administrator. The plans where this is not possible, or where the state itself bears a guarantee over the payout, have had greater difficulty and bear more risk. This can be a great deal for investors when a state is able to honor its promises, but the risk is still significant, as shown by Alabama and its troubled PACT plan.

Though difficult, it is not impossible for a state to run a successful prepaid tuition plan, as has been shown by states like Florida and Massachusetts, so states considering this route are likely to look to their peers for models. It is unlikely, however, to see many states offering additional prepaid tuition plans. The benefits to the state are limited, the terms restrictive by the nature of the programs, and the risks significant to all parties.

RELATED: Think twice before sending clients to a direct-sold plan