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COLLEGE SAVINGS 101

Does your state's prepaid tuition plan make sense?
http://www.savingforcollege.com/articles/20100108-Does-your-states-prepaid-tuition-plan-make-sense

Posted: 2010-01-08

by Joseph Hurley, CPA and Greg McBride, CFA

While stock portfolios and home values suffered major losses and "safe" investments turned out to be anything but over the past 18 months, many parents and grandparents are wondering if there's a better hedge against ever-escalating college costs than prepaid tuition programs.

After all, as the recession knocked 55 percent off the stock market's value and a nearly equal percentage was lopped off home values in some parts of the country, college tuition continued to chug ever higher and seems bound to join death and taxes as virtual certainties.

At first glance, prepaid tuition plans may appear to be that perfect hedge: They can look like a method to buy "tomorrow's tuition at today's prices," thereby eliminating an investor from relying on appreciation in the value of other asset classes.

The Florida Prepaid College Plan nicely illustrates the point and may prove helpful not only to Floridians, but also to residents in other states that are considering prepaid tuition programs.

Let's begin by dispelling the biggest misconception about the Florida Prepaid College Plan, and perhaps those of some other states as well. Prepaid tuition plans are often thought of, or even marketed as, "buying future tuition at today's prices." With regard to the Florida Prepaid College Plan, that is not the case at all. In fact, you're buying future tuition -- but at very inflated prices.

First, keep in mind that the cost of the plan depends on the age and grade of the child when you purchase the plan. Secondly, the plan can be paid for in a lump-sum, upfront payment or on a five-year or monthly payment plan in which the payment never increases.

Let's say you wanted to purchase the plan for your child who is enrolled in kindergarten this year -- and who would be entering college in 2022. Under the lump sum plan, the single-payment for 120 credit hours would be $15,202.65. But the plan also provides for a "Tuition Differential Plan" fee -- an added charge which is described as allowing Florida state universities to "raise revenue to improve the quality of undergraduate instruction and to increase the availability of financial aid."

The tuition differential fee for this same child this year would be $17,745.31.

Therefore, the total lump-sum or single-payment cost to purchase this prepaid plan for a kindergarten student would be $32,947.96 -- or $274.56 per credit hour. The price goes down the older your child is because fewer years will elapse until your child enters school and, presumably, the tuition and differential costs will not rise as much:

2nd grade -- $269.10
6th grade -- $246.46
8th grade -- $213.20

Needless to say, if the current cost per credit hour at Florida state universities is $102.33, it doesn't take an MBA to recognize you're not paying anything close to today's prices on that future tuition.

For the cost per credit hour to rise from $102.33 to $213.20 by the time today's eighth-grader reaches college, the assumption is that costs rise at 15 percent annually for the next five years. Even if that proves to be the case, the parent of an eighth-grader will have managed only to buy future tuition at future prices -- but pay for it today. Under Florida law, the aggregate sum of base tuition and the tuition differential may not be increased by more than 15 percent over the preceding fiscal year.

Should prices rise slower than 15 percent annually, then the prepaid plan turns out to be a money-losing investment as the parent will actually be paying more per credit hour than the students who did not purchase a prepaid plan.

This particular package is not the only option provided in the Florida Prepaid College Plan. One can purchase the base four-year state university tuition plan that excludes the tuition differential fee. The cost for an eighth-grader comes out to $119.76 per credit hour, a price that is "only" 35 percent above the current base tuition level. However, base tuition in Florida is more closely regulated by the state and unlikely to come anywhere near a 15 percent annual increase. Some may purchase the tuition plan without the tuition differential -- thinking they are saving money -- but it would mean much higher payouts in the long term.

Using a monthly payment plan or a five-year payment plan for the Florida Prepaid College Plan, instead of the lump sum, means financing those payments at an "average effective interest rate of 3.88 percent" which involves not only paying the aforementioned hefty premium -- but financing it as well.

What happens if you cancel the plan? Different states have different rules, but the Florida plan permits you to get your money back. But you only get back what you invested, with no interest, and less any administrative fees. In effect, you earn a negative real return as the money returned to you isn't adjusted for inflation or tuition increases in the period of time it was invested.

What follows is a brief recap of the pricing in several other states offering a prepaid tuition plan to its residents. As you can see, most -- but not all -- charge a substantial premium, although none as large as Florida's tuition and fee differential package.

Illinois
Program name: College Illinois!
Cost/Benefit: This prepaid tuition plan has three basic plans:

  • Community College Plan covering Illinois community colleges.
  • University Plan covering Illinois public universities, except for University of Illinois at Urbana-Champaign (UIUC).
  • University+ Plan covering UIUC.

A multitude of pricing schedules exists. A family that signs up for two semesters of the University+ Plan in January 2010 (lump-sum payment option due March 1, 2010) for a ninth-grader will pay $19,659 or $655.30 per credit hour. The most expensive curriculum at UIUC currently costs $561.60 per credit hour.

Maryland
Program name: College Savings Plan of Maryland -- Prepaid College Trust
Cost/Benefit: A family that signs up for the one-year University Plan for a ninth-grader will pay $9,876 or $329.20 per credit hour (lump-sum payment option). The payment is due Aug. 1, 2010. The projected weighted average tuition and fees at Maryland public universities in 2010-11 is $8,113 or $270.43 per credit hour.

Michigan
Program name: Michigan Education Trust (MET)
Cost/Benefit: A family signing up for one year of the Full Benefits contract for a ninth-grader (lump-sum option with payment due with application) will pay $12,800 or $427.00 per credit hour. The Full Benefits contract is appropriate for the student who intends to enroll at one of the more expensive Michigan public universities (tuition for 2009-10 at the University of Michigan is $11,659 for lower-division students and $13,141 for upper-division students). The Limited Benefits contract costs substantially less -- $10,310 for a year or $343.67 per credit hour -- but caps the payout at 105 percent of the weighted average tuition at Michigan publics. According to MET's Web site the weighted average tuition in 2009-10 of Michigan's four-year public institutions is $9,372 or $302.27 per credit hour.

Mississippi
Program name: Mississippi Prepaid Affordable College Tuition (MPACT) Program
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump-sum payment option due Feb.1, 2010) will pay $5,161 for up to 32 credit hours or $161.28 per credit hour. The 2009-10 weighted average tuition for Mississippi universities covered by this plan is $154.59 per credit hour.

Nevada
Program name: Nevada Prepaid Tuition Program
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump-sum payment option due May 15, 2010) will pay $5,237 or $174.57 per credit hour. The 2009-10 tuition at the University of Nevada is $136.00 per credit hour.

Pennsylvania
Program name: Pennsylvania Guaranteed Savings Plan
Cost/Benefit: The tuition credits purchased through this plan are redeemable for an amount equal to average tuition at schools within one of five categories. The participant selects the category, either:

  • The PA State System of Higher Education.
  • PA State-related Universities.
  • PA Community Colleges.
  • Ivy League Colleges.
  • Private Four-Year Colleges.

A family selecting the first or third categories will pay a price for their tuition credits equal to current average tuition at those institutions; a family selecting the second category will pay a price for their tuition credits 8 percent above current average tuition at State-related Universities; and a family selecting the fourth or fifth categories will pay a price for their tuition credits 2 percent above current average tuition at those institutions. Participants in this plan are also charged an annual account-maintenance fee equal to 0.49 percent ($4.90 on each $1,000 of value).

Tennessee
Program name: Tennessee's BEST Prepaid College Tuition Plan
Cost/Benefit: Each unit acquired in this plan is worth 1 percent of the weighted average tuition at Tennessee's public four-year universities and may be redeemed for use at any eligible educational institution in the country. The per-unit price is $72.52 per unit as of Jan. 1, 2010. The per-unit payout value for the 2009-10 school year is $61.20 per unit.

Texas
Program name: Texas Tuition Promise Fund
Cost/Benefit: Because this particular plan was designed by the Texas legislature to shift investment risk to the state schools, participating families are able to purchase future Texas tuition at today's prices -- no premium is charged. However, a student attending a private college or out-of-state institution will receive the lesser of in-state tuition value or the original price paid plus actual fund investment performance.

Virginia
Program name: Virginia Prepaid Education Program (VPEP)
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump sum payment option due May, 1, 2010) will pay $11,083 or $369.43 per credit hour. Virginia tuition varies widely among its public institutions. For the 2009-10 school year, the highest-cost institution is VMI with tuition of $11,190 or $373 per credit hour. However, the average tuition at Virginia's public institutions is $7,995 or $266.50 per credit hour.

Washington
Program name: Guaranteed Education Tuition (GET)
Cost/Benefit: Each unit in this plan is worth 1 percent of the resident undergraduate tuition at the highest-priced Washington state public university and may be redeemed for use at any eligible institution in the country. The per-unit price is $101 through April 1, 2010. The per-unit payout value for the 2009-10 school year is $76.

Posted January 8, 2010

While stock portfolios and home values suffered major losses and "safe" investments turned out to be anything but over the past 18 months, many parents and grandparents are wondering if there's a better hedge against ever-escalating college costs than prepaid tuition programs.

After all, as the recession knocked 55 percent off the stock market's value and a nearly equal percentage was lopped off home values in some parts of the country, college tuition continued to chug ever higher and seems bound to join death and taxes as virtual certainties.

At first glance, prepaid tuition plans may appear to be that perfect hedge: They can look like a method to buy "tomorrow's tuition at today's prices," thereby eliminating an investor from relying on appreciation in the value of other asset classes.

The Florida Prepaid College Plan nicely illustrates the point and may prove helpful not only to Floridians, but also to residents in other states that are considering prepaid tuition programs.

Let's begin by dispelling the biggest misconception about the Florida Prepaid College Plan, and perhaps those of some other states as well. Prepaid tuition plans are often thought of, or even marketed as, "buying future tuition at today's prices." With regard to the Florida Prepaid College Plan, that is not the case at all. In fact, you're buying future tuition -- but at very inflated prices.

First, keep in mind that the cost of the plan depends on the age and grade of the child when you purchase the plan. Secondly, the plan can be paid for in a lump-sum, upfront payment or on a five-year or monthly payment plan in which the payment never increases.

Let's say you wanted to purchase the plan for your child who is enrolled in kindergarten this year -- and who would be entering college in 2022. Under the lump sum plan, the single-payment for 120 credit hours would be $15,202.65. But the plan also provides for a "Tuition Differential Plan" fee -- an added charge which is described as allowing Florida state universities to "raise revenue to improve the quality of undergraduate instruction and to increase the availability of financial aid."

The tuition differential fee for this same child this year would be $17,745.31.

Therefore, the total lump-sum or single-payment cost to purchase this prepaid plan for a kindergarten student would be $32,947.96 -- or $274.56 per credit hour. The price goes down the older your child is because fewer years will elapse until your child enters school and, presumably, the tuition and differential costs will not rise as much:

2nd grade -- $269.10
6th grade -- $246.46
8th grade -- $213.20

Needless to say, if the current cost per credit hour at Florida state universities is $102.33, it doesn't take an MBA to recognize you're not paying anything close to today's prices on that future tuition.

For the cost per credit hour to rise from $102.33 to $213.20 by the time today's eighth-grader reaches college, the assumption is that costs rise at 15 percent annually for the next five years. Even if that proves to be the case, the parent of an eighth-grader will have managed only to buy future tuition at future prices -- but pay for it today. Under Florida law, the aggregate sum of base tuition and the tuition differential may not be increased by more than 15 percent over the preceding fiscal year.

Should prices rise slower than 15 percent annually, then the prepaid plan turns out to be a money-losing investment as the parent will actually be paying more per credit hour than the students who did not purchase a prepaid plan.

This particular package is not the only option provided in the Florida Prepaid College Plan. One can purchase the base four-year state university tuition plan that excludes the tuition differential fee. The cost for an eighth-grader comes out to $119.76 per credit hour, a price that is "only" 35 percent above the current base tuition level. However, base tuition in Florida is more closely regulated by the state and unlikely to come anywhere near a 15 percent annual increase. Some may purchase the tuition plan without the tuition differential -- thinking they are saving money -- but it would mean much higher payouts in the long term.

Using a monthly payment plan or a five-year payment plan for the Florida Prepaid College Plan, instead of the lump sum, means financing those payments at an "average effective interest rate of 3.88 percent" which involves not only paying the aforementioned hefty premium -- but financing it as well.

What happens if you cancel the plan? Different states have different rules, but the Florida plan permits you to get your money back. But you only get back what you invested, with no interest, and less any administrative fees. In effect, you earn a negative real return as the money returned to you isn't adjusted for inflation or tuition increases in the period of time it was invested.

What follows is a brief recap of the pricing in several other states offering a prepaid tuition plan to its residents. As you can see, most -- but not all -- charge a substantial premium, although none as large as Florida's tuition and fee differential package.

Illinois
Program name: College Illinois!
Cost/Benefit: This prepaid tuition plan has three basic plans:

  • Community College Plan covering Illinois community colleges.
  • University Plan covering Illinois public universities, except for University of Illinois at Urbana-Champaign (UIUC).
  • University+ Plan covering UIUC.

A multitude of pricing schedules exists. A family that signs up for two semesters of the University+ Plan in January 2010 (lump-sum payment option due March 1, 2010) for a ninth-grader will pay $19,659 or $655.30 per credit hour. The most expensive curriculum at UIUC currently costs $561.60 per credit hour.

Maryland
Program name: College Savings Plan of Maryland -- Prepaid College Trust
Cost/Benefit: A family that signs up for the one-year University Plan for a ninth-grader will pay $9,876 or $329.20 per credit hour (lump-sum payment option). The payment is due Aug. 1, 2010. The projected weighted average tuition and fees at Maryland public universities in 2010-11 is $8,113 or $270.43 per credit hour.

Michigan
Program name: Michigan Education Trust (MET)
Cost/Benefit: A family signing up for one year of the Full Benefits contract for a ninth-grader (lump-sum option with payment due with application) will pay $12,800 or $427.00 per credit hour. The Full Benefits contract is appropriate for the student who intends to enroll at one of the more expensive Michigan public universities (tuition for 2009-10 at the University of Michigan is $11,659 for lower-division students and $13,141 for upper-division students). The Limited Benefits contract costs substantially less -- $10,310 for a year or $343.67 per credit hour -- but caps the payout at 105 percent of the weighted average tuition at Michigan publics. According to MET's Web site the weighted average tuition in 2009-10 of Michigan's four-year public institutions is $9,372 or $302.27 per credit hour.

Mississippi
Program name: Mississippi Prepaid Affordable College Tuition (MPACT) Program
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump-sum payment option due Feb.1, 2010) will pay $5,161 for up to 32 credit hours or $161.28 per credit hour. The 2009-10 weighted average tuition for Mississippi universities covered by this plan is $154.59 per credit hour.

Nevada
Program name: Nevada Prepaid Tuition Program
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump-sum payment option due May 15, 2010) will pay $5,237 or $174.57 per credit hour. The 2009-10 tuition at the University of Nevada is $136.00 per credit hour.

Pennsylvania
Program name: Pennsylvania Guaranteed Savings Plan
Cost/Benefit: The tuition credits purchased through this plan are redeemable for an amount equal to average tuition at schools within one of five categories. The participant selects the category, either:

  • The PA State System of Higher Education.
  • PA State-related Universities.
  • PA Community Colleges.
  • Ivy League Colleges.
  • Private Four-Year Colleges.

A family selecting the first or third categories will pay a price for their tuition credits equal to current average tuition at those institutions; a family selecting the second category will pay a price for their tuition credits 8 percent above current average tuition at State-related Universities; and a family selecting the fourth or fifth categories will pay a price for their tuition credits 2 percent above current average tuition at those institutions. Participants in this plan are also charged an annual account-maintenance fee equal to 0.49 percent ($4.90 on each $1,000 of value).

Tennessee
Program name: Tennessee's BEST Prepaid College Tuition Plan
Cost/Benefit: Each unit acquired in this plan is worth 1 percent of the weighted average tuition at Tennessee's public four-year universities and may be redeemed for use at any eligible educational institution in the country. The per-unit price is $72.52 per unit as of Jan. 1, 2010. The per-unit payout value for the 2009-10 school year is $61.20 per unit.

Texas
Program name: Texas Tuition Promise Fund
Cost/Benefit: Because this particular plan was designed by the Texas legislature to shift investment risk to the state schools, participating families are able to purchase future Texas tuition at today's prices -- no premium is charged. However, a student attending a private college or out-of-state institution will receive the lesser of in-state tuition value or the original price paid plus actual fund investment performance.

Virginia
Program name: Virginia Prepaid Education Program (VPEP)
Cost/Benefit: A family that signs up for one year of the University Plan for a ninth-grader (lump sum payment option due May, 1, 2010) will pay $11,083 or $369.43 per credit hour. Virginia tuition varies widely among its public institutions. For the 2009-10 school year, the highest-cost institution is VMI with tuition of $11,190 or $373 per credit hour. However, the average tuition at Virginia's public institutions is $7,995 or $266.50 per credit hour.

Washington
Program name: Guaranteed Education Tuition (GET)
Cost/Benefit: Each unit in this plan is worth 1 percent of the resident undergraduate tuition at the highest-priced Washington state public university and may be redeemed for use at any eligible institution in the country. The per-unit price is $101 through April 1, 2010. The per-unit payout value for the 2009-10 school year is $76.

Posted January 8, 2010

 

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