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529 E-ditorials

03-5: Privatizing Prepaid
Joe Hurley
Thursday, October 30th 2003

Three separate news items this month are making me think the state-run prepaid tuition plan may be going the way of the dinosaur.

The first was Ohio’s decision to suspend enrollment in its prepaid tuition plan (a.k.a. the Guaranteed Savings Option of the CollegeAdvantage Savings Plan). This follows similar actions in Colorado, West Virginia, Texas, and Kentucky. The move was not entirely unexpected; program officials had been grappling with the combination of spiraling tuition and a poor investment climate for the last couple of years, and had increased the price of tuition units several times, to the point where each unit cost as much as 49 % more than its current value. The discouraging part of all this is that Ohio’s prepaid program is one of the oldest and largest prepaid programs in the country. (See more about the Ohio situation here.)

The second item was an admission by the executive director of the Pension Benefit Guaranty Corporation (PBGC) to a U.S. Senate special committee that the PBGC was running huge deficits and might have to seek a multi-billion dollar bailout from the federal government in the future. What does this have to do with prepaid tuition plans? The PBGC is facing many of the same economic challenges in insuring the obligations of defined benefit pension plans that prepaid tuition programs are facing in assuming the tuition obligations of their participants. However, the PBGC can react to underfunding in pension plans by increasing the premiums paid by covered employers, an option generally not available to prepaid tuition plans.

The third item was the College Board’s announcement that this year’s average tuition at four-year public universities is 14.1 percent higher than last year (13.8 percent higher at two-year public colleges). The comparable figure reported a year ago was “only” 9.6 percent. Clearly, the trend is going in the wrong direction.

So how is it that a new prepaid tuition plan—the Independent 529 Plan—could have launched with such fanfare and high expectations in September? Simple. Unlike the typical state-run prepaid program or the PBGC, the Independent 529 Plan doesn’t act as a third-party insurer/payer. Each member college is willing to accept the risk that it will receive less than full payment if investment returns on prepaid moneys don’t keep pace with its tuition increases.

Colleges signing up with the Independent 529 Plan must see some benefit in accepting that investment risk. Perhaps they expect to gain a leg up in the recruiting process. Or maybe they’ll be able to attract students with less need for financial aid so the colleges’ aid resources can be redirected to others. Perhaps they subscribe as a matter of policy, to counter Congressional critics of increasing college costs. Whatever the reason, the result is that every family now has the opportunity to buy at least some degree of tuition protection (see below for a discussion of who should consider using the Independent 529 Plan).

If private colleges see a benefit to prepaid tuition, it seems to me that public institutions should as well. To date, most public institutions have been passive recipients of tuition dollars coming from the state prepaid programs. Why can’t they join up with the Independent 529 Plan, or start prepaid programs of their own? Such a move would demonstrate the serious commitment of state government and higher-education officials to hold the line on tuition increases. To date we’ve seen only the University of Alaska and some schools in Massachusetts go in this direction. I’m not naïve enough to expect that other state university systems will embrace this idea; the complexities of a subsidized system do not easily accommodate it. But it would be nice to see some serious consideration given.

We’ll have to wait and see whether improving economic conditions and remedial actions will permit the remaining state-run prepaid tuition plans to avoid the dinosaur’s fate. Programs in states like Florida, where tuition is tightly regulated, or where the state is willing to provide a taxpayer-funded bailout, can remain viable. For some other states, it may be just a matter of time.

Who should be interested in the Independent 529 Plan?

The primary attraction of the Independent 529 Plan is the opportunity to lock in future college tuition at today’s prices. (Actually, you get more than your dollar would buy today, since participating colleges must offer a discount of at least one-half percent per year.) The downside is the risk that your child or grandchild will not be attending one of the participating colleges, in which case the amount you receive back is limited to your investment plus two percent per year. (Or, with poor investment performance, a loss of up to two percent per year.) Another negative is the federal financial aid treatment of prepaid tuition plans under Department of Education rules.

Unless you have a pretty slick crystal ball, the decision to join the Independent 529 Plan can be a difficult one. It’s made easier if you fall into one of the following categories:

  • Your alma mater is a member of the Independent 529 Plan, its new $20 million library is named after your grandfather, and Junior intends to follow in your footsteps.

  • You’re a grandparent and believe the purchase of a tuition certificate sends a powerful message to your grandchild (and to his or her parents) about the importance of a college degree. You may not care that Junior ultimately decides to attend a non-participating school because the gift is already out of your pocket, and you’ve made your point. It won’t bother the parents, either, because as far as they are concerned your gift is 100% gain no matter how much it turns out to be worth.

  • Your child has already been accepted at a college belonging to the plan. Although you can’t prepay tuition bills that come due within 36 months, that still leaves at least one year open.

  • You just can’t stand the thought of tuition prices getting further out of reach, and you’re willing to accept the risk that that your child won’t be going to a college in the plan. In fact, you’re hoping that by the time he or she begins applying, the number of colleges participating in the Independent 529 Plan has increased from its current 220 to 2,000.

The Independent 529 Plan is not the only tuition program that involves a direct commitment from the educational institution.

Here are a few others we know about:

  • The Massachusetts U.Plan, begun in 1995, was the model for the Independent 529 Plan. Participating colleges include over 80 private and public institutions located within Massachusetts. Although the U.Plan does not appear to qualify as a 529 plan under IRS regulations, the use of state general-obligation bonds as the investment mechanism means that benefits are not subject to federal or Massachusetts income tax.

  • The ACT Portfolio is a balanced investment option in the University of Alaska College Savings Plan, but with a special twist. If an account beneficiary attends the University of Alaska, and the investment returns on the ACT option do not keep pace with UA tuition increases, the program makes up the difference. Alaska is the only state where the public university system is actually a state agency, so the guarantee is a direct one.

  • The SAGE Scholars program, operated by a private company, involves contractual agreements with over 150 private colleges. Each college promises to discount its tuition for any SAGE participant attending that college, regardless of the family’s financial condition. The amount of guaranteed discount is calculated based on a percentage of assets invested with certain investment providers and 529 plans, capped at one year’s tuition (spread over four payment years).

  • A number of colleges permit students to pay four years of tuition up front. By doing so, the current tuition is locked in for the full four years.

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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