BY TERRY SAVAGE
Will your college prepaid tuition plan be able to pay off in the end? That’s the question people in many states have had to consider as more and more states have closed or modified their plans, admitting the plans cannot generate sufficient growth to keep up with the promise to cover future tuition payments.
The most recent closing came in early December, as CollegeIllinois! — the state’s prepaid tuition plan — announced it had closed and is no longer selling contracts. It’s the second time in recent years the program has been closed as it struggles to fill a $320 million gap between the money it has taken in on prepaid tuition contracts and the cost of the promised tuition.
Prepaid tuition plans
Prepaid tuition plans are one form of college savings under the 529 college savings plan program. The most popular have been the “investment-type” plans, where the money deposited in the account grows tax free for college expenses — and can be used for any college, in any state, and for any child in the family.
Prepaid tuition plans are used only for tuition and only in the state in which they were purchased. The sole and excellent exception is the Private College 529 Plan, which is sponsored by some of the nation’s leading colleges and universities. That plan absolutely guarantees their contracts will be worth tuition at participating schools.
The idea of prepaid tuition plans is to pay for tuition now, when your child is young, and redeem the contracts for tuition in the future, when college presumably will be far more costly. These plans are supposed to invest the money wisely to keep up with the rate of college cost inflation.
But that hasn’t happened in many plans. Many state plans have closed down or struggled in recent years — including plans offered by Washington, South Carolina, Virginia and Tennessee. The Alabama plan shut down in 2009 during the financial crisis. Virginia is in the midst of restructuring its prepaid tuition plan.
CollegeIllinois! has been in trouble for years as questionable private equity investments made with plan money came to light. Worst of all, Illinois is one state that does not guarantee the plan payouts; it only has a “moral obligation” to make good. The legislature would have to vote to appropriate money to make good on the contracts. And this is a state that couldn’t pass a budget for two years.
After the recent closing announcement, the Illinois plan has not explained how it will handle payouts for tuition contracts that mature this year — much less years down the road.
According to Brian Boswell at 529Expert.com, states vary in the legal promises they make in their contracts. Some states have fully guaranteed the tuition payments. Others with underfunded plans have distributed funds with a discount or allowed investors to roll over the money into 529 College Savings investment plans.
Theoretically, a state could issue “vouchers” for the promised tuition contracts. State schools would have to accept those promises — even though they don’t represent money to pay professors and other costs.
Importantly, a prepaid tuition plan shutdown has no impact on any state’s investment-type 529 plan. (In Illinois, BrightStart Savings is the state’s tax-free college savings investment plan.) These plans allow a choice of mutual funds, and money is held by trusted fund management companies. All funds, including gains, are withdrawn tax free for college expenses.
If you have purchased a prepaid college tuition 529 plan, this is a good time to learn more about the guarantees and promises. You can do that at SavingforCollege. com, where you can also see the performance ratings and costs of the various state investment-type 529 plans.
Investment-type 529 plans can be rolled into another state’s plan — a process that must be done carefully to avoid taxes. Prepaid plans, however, are tied to the fortunes and investment savvy of each state’s plan — and to their guarantees.