Told Ya So.
If you have college-bound children, you know -- and fear -- the costs of college. To help parents deal with the cost, states created Tuition Prepayment Plans. The pitch is simple: By signing up for the plan, you lock in today’s tuition rate, and begin paying for future tuition costs. It’s a nice story, and tens of thousands of families across the country have joined these programs.
That’s unfortunate because, as I’ve been saying for years, the plans have severe limitations and are based on promises that the states wouldn’t keep. And now, my warnings have become reality.
Let’s talk about the limitations and the flaws separately. The former are plentiful: The plans cover tuition only. Yet room and board, books and personal expenses make up half or more of the cost of college. Thus, many parents incorrectly believe that “college is paid for” when they join a TPP; in truth, they’ve paid only part of the total cost.
Also, the program is limited to public colleges and universities in your state. There is no assurance that your child will be accepted. If not, you get your money back, perhaps without interest (depending on the state). Ditto if your kid doesn’t want to go college, or wants to attend a private college or a school outside your state. And say you join your state plan but later move to another state. Your child will have to attend a school in your former state-of-residence, but he or she will be regarded as an out-of-state student. As a result, the TPP won’t cover the full cost of tuition, because it pays only in-state rates; you’d have to pay the rest.
These limitations are reason enough to avoid Tuition Prepayment Plans. Even worse are the two fundamental flaws that, in my opinion, kill any basis for their consideration by college-saving parents. Those flaws lie in two assumptions made by the states: future college inflation rates and investment rates of return.
You see, when joining a TPP, you send money to the state government. The amount you have to send -- either in a single payment or series of monthly payments -- is based on what the state believes college will cost by the time your child attends. Thus, the state is making an assumption about the annual rate of tuition inflation. Second, the state invests the money you send it, and thus makes an assumption about how much it will earn on those investments. The lower the assumed rate of inflation and the higher the assumed rate of return on investments, the less money you must send in.
Yup, you guessed it: States across the country have made really bad assumptions. This was my biggest worry, and has been the primary reason I so strongly opposed the use of TPPs as a college savings strategy. After all, when did state governments become brilliant money managers?
We know what’s happened since these programs were created: College tuition has risen at double-digit rates, while investment returns over the past three years have been negative.
As a result, government officials in almost every state that offers a prepaid tuition plan have announced that their programs are not working as expected. For example, Colorado told all 7,800 families who enrolled in its plan that they had until this past February 20th to withdraw from the plan. Last year, Ohio increased the cost of its plan by 53%, even though tuition in the state had grown only 15%. Wisconsin has stopped selling its plan altogether. Florida says it might kick out all middle class families, allowing only low income families to remain in the program. Maryland has boosted the cost of its plan by 30%, Virginia upped its plan cost by 25%, and Illinois 23%. West Virginia says its plan will only be able to cover tuition for 83% of the kids who are enrolled.
These programs were supposedly “guaranteed” by the states. We now know that the word “guaranteed” is meaningless because the legislatures have simply reneged on the deal. If you had joined a plan, you now are discovering that you must pay much more than you were told -- and that’s if you’re lucky. In some states, like Colorado, the deal’s off entirely, and you’re just going to get your money back.
Can you imagine a private company reneging on its promises in this way? Lawsuits would be flying, and headlines would be screaming. But these are state-run programs; you can’t sue the government, and stories of government mismanagement are all too common.
So what is a parent to do? If you want to save for a child’s or grandchild’s college, establish an account in the Section 529 College Savings Plan. Although organized by the states, the money is managed by professional money managers. The money you invest grows tax-deferred and withdrawals under current law are federal tax-free and can be used for all college expenses -- tuition, room and board, books, computers -- in any college in the country, public or private. Unused money can be transferred to another child in the family and even held for the benefit of your child’s future children. Talk with your financial advisor about 529 plans soon -- you can even transfer your current TPP monies into it.
And the next time I warn you about something...
Pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001, effective Jan. 1, 2002, through Dec. 31, 2010, unless legislation changes. Nonqualified withdrawals are taxed on the earnings portion of the withdrawals. State and other penalties may also apply. For more complete information, including a description of fees, expenses and risks, you should review the plan offering statement carefully. State income taxes may continue to apply. Please consult your tax counsel regarding tax consequences under your specific circumstances.