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

Posted: 2016-11-17

by Brian Boswell

Financial Professional Content

Most press coverage and even our own here at Savingforcollege.com focuses on the "savings" variety of 529 plan. But what of the prepaid plans, particularly state-sponsored prepaid 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 prepaids 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 plan. There are only 19 prepaid plans compared with over 80 savings plans, and of those only 11 prepaids are still available to new investors.

Prepaid 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 plans to limit enrollment and create predictable revenues and costs. For example:

  • Most prepaid 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 college savings plans: Here's what you need to know

A timeline of prepaid 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 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 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 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 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 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 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 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 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

Financial Professional Content

Most press coverage and even our own here at Savingforcollege.com focuses on the "savings" variety of 529 plan. But what of the prepaid plans, particularly state-sponsored prepaid 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 prepaids 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 plan. There are only 19 prepaid plans compared with over 80 savings plans, and of those only 11 prepaids are still available to new investors.

Prepaid 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 plans to limit enrollment and create predictable revenues and costs. For example:

  • Most prepaid 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 college savings plans: Here's what you need to know

A timeline of prepaid 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 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 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 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 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 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 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 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 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

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