States worried about viability of prepaid college savings plans

Mar 27, 2011 @ 12:01 am

By Liz Skinner

Faced with escalating tuition costs and lackluster investment returns, some states are considering plans to cut back on the benefits offered through their prepaid college savings plans.

In Florida, home of the nation's largest prepaid college plan — with 1.4 million participants — state legislators are trying to decide whether some participants should be required to cover more of the costs of what has been a 15% increase last year in tuition and fees at most Florida universities.

They also are considering plans to close the state's prepaid tuition plan to new participants for one year.

Meanwhile, in Washington state, legislators are weighing a plan to revalue its program's education credits so that their worth is based on the average one-year tuition of all state institutions, as opposed to the cost of attending the most expensive school. Tuition at Washington State University, the most expensive public school, climbed 13.1% in each of the past two years and now stands at $8,592 a year.

The move is intended to keep the state off the hook for more education costs than it can afford.

“Tuition is going up faster than was originally assumed for the long term, and in a lot of cases, investments aren't doing as well,” said Betty Lochner, director of the state of Washington's Guaranteed Education Tuition plan. “That presents concerns about long-term viability.”

Florida and Washington aren't alone. Officials from many of the 15 states with open prepaid college plans likely are scrutinizing the health of their plans to make sure that they have enough funds to pay for the education that they have promised investors, said Joan Marshall, chairman of the College Savings Plan Network, a nonprofit organization affiliated with state treasurers.

In Illinois, for example, lawmakers face a $1.1 billion shortfall in the state's prepaid plan because of tuition increases. Consequently, the state shifted its investment allocation to include more alternative investments, such as hedge funds, real estate and private equity to try to boost returns.

In prepaid plans, families generally buy “units” of education credits at a price set by the state. Essentially, the plans allow families to pay for college years down the road at prices set today.

The states invest the money that they collect from participants with the expectation that their investment gains will more than offset tuition costs.

Many states, however, are finding that their investment performance assumptions are too aggressive and the predictions that they made about tuition rates too conservative.

The average cost of tuition and fees at a state university increased 7.9% this year from the 2009-10 academic year to $7,605 for in-state students and 6% to $19,595 for out-of-state residents, according to The College Board. When you include room and board, total costs rose 6.1% this year for in-state residents to $16,140 and 6% for out-of-state students to $28,130.

Over the past decade, nine states — Alabama, Colorado, Kentucky, Michigan, Ohio, South Carolina, Tennessee, Texas and West Virginia — closed prepaid plans to new investors to ensure that they could meet their existing financial obligations. Michigan and Texas later started new prepaid plans.

Other states with prepaid plans are Illinois, Maryland, Massachusetts, Mississippi, Nevada, Pennsylvania and Virginia.

“There's a lot of uncertainty with the prepaids right now, and that's exactly the opposite of what attracted investors to them in the first place,” said Stephen Jobe, director, iShares 529 plans at BlackRock Inc..

Financial advisers always have had a rocky relationship with the prepaid college plans, often thinking that other vehicles would be more flexible and earn higher returns. Section 529 college savings plans, which allow parents or grandparents to contribute post-tax dollars to an account and choose from a selection of investments, are more popular with advisers than the prepaids.

“Advisers like control, and they have zero control in prepaid plans,” said Mr. Jobe, whose firm has about $7.8 billion in assets under management in six 529 plans.

Deborah Fox, a San Diego financial adviser who specializes in helping families save for college, said that she isn't recommending prepaids because she isn't confident that “what the state is promising will actually happen in 18 years.”

“How can they guarantee the plan's intended performance when they are on the verge of bankruptcy?” she said.

Some 529 plans have had to cut fees to make them more attractive, including those in Alaska, Connecticut, Iowa, Maryland, Michigan, Missouri, Nevada, Pennsylvania and Virginia.

The troubles of the nation's prepaid college savings plans only aggravate Americans' worries about whether they can cover future college costs.

More than half, or 51%, of people interviewed in a recent survey said that they are “very worried” about future higher-education costs, while 35% said that they are “very worried” about whether they will be able to afford to retire.

About 17% said that they are “very worried” about losing their jobs, according to the Public Agenda, which released the results of its telephone survey of 1,004 adults last month.

“There's a growing sense that a college education is necessary to be economically successful in today's work force,” said Public Agenda research director Jon Rochkind. “Their increasing belief in the importance of college, paired with their knowledge that college is getting more expensive, increases their anxiety.”

Rick Darvis, co-founder of the National Institute of Certified College Planners and a certified public accountant, advocates funding college through accounts that can be used for other things, such as individual retirement accounts that can be used for education without paying a penalty.

“With today's economy, you need diversity in your investments for college.” he said.

E-mail Liz Skinner at lskinner@investmentnews.com.

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