Wednesday, February 16, 2011

Prepaid College Tuition Plans: Too Good to Be True

More and more states are closing their prepaid college tuition plans to new participants, raising the cost of participation, or limiting the benefits provided by not bailing out underfunded plans. Many parents are unhappy. Some have sued.

These plans, which promised to cover state university tuition costs for beneficiary students residing in the state offering the plan, were like a futures contract. Someone, usually the parents, would buy now, and years later the student would take delivery of a college education without paying the tuition in effect at the time of enrollment. A few years ago, prepaid tuition was a pretty good deal if you could be sure your child would attend a state university covered by the program. It was less good if your child went to another school, although you could apply some of the value of your account to other schools' tuition charges.

But just as roses have thorns, fine print in the policies of many programs took the state off the hook if tuition costs rose faster than expected. There was no guarantee that the programs would stay open, or that new participants wouldn't have to pay higher costs than previous participants.

Since the financial crisis of 2007-08, state university tuition charges have, on average, risen faster than private college tuition. Pinched by falling tax revenues from the Great Recession, states cut their support to higher education, at a time when endowments took investment losses while alumni contributions became more uncertain. Not surprisingly, the state legislators who cut support for their state's university system wouldn't want to be backdoored by rising costs from the prepaid tuition program. So in some instances they whacked away at that program, too.

Looking at the problem on the state level misses an important point, though. Prepaid tuition programs are really structured financial products, not unlike so many other fancy engineered investments from Wall Street that haven't worked out so well. Money managers sold state officials on the idea that investment skill could mitigate the risks of rising tuition costs. Nice story and it would play well with the voters. But the boom-bust cycles that have skewered asset values time and again over the past decade have made laughing stock of money managers (except that it really wasn't funny when everyone's 401(k)s got clobbered). And no state has escaped pressure from falling tax collections due to the Great Recession. It's easy to offer guarantees when asset values are stable and usually rising, and the economy is growing. But when asset values are volatile, and times are tough, things that are too good to be true won't be true.

There are plenty of potential candidates for blame, from Wall Street to the Fed to money managers to state officials to university administrators. But placing blame doesn't much help kids now strapped for college funds. If you want to play it safe, forget about prepaid college tuition plans, and save as much as you can for your kids' education. Using 529 college savings plans can be a good idea if the expenses are low and you can get a deduction on your state income taxes. You'll be better off if you accept the fact that there really are no guarantees in life and plan on taking care of things yourself.

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