At first blush, pre-paid tuition plans seem like a pretty good deal, especially with interest-bearing accounts giving little and tuition rising 6 to 7 percent a year.
Prepaid tuition plans, one type of 529 Plans, allow families to buy all or part of a public, in-state education at present-day prices. The value of the investment is guaranteed by the state to meet or exceed annual in-state public college tuition inflation.
That may sound like a good thing, but let’s consider the history of another government-backed program – Social Security.
In 1936 less than 5% of adults had a college degree when the government announced a new program to provide citizens “something to live on when they are old and stop working.” Employees were promised that “the most you will ever pay” is 3 cents of every dollar earned up to $3,000. Even better, the feds assured investors still nervous from the 1929 crash that benefits “will always be more than you have paid in taxes and usually more than you can get for yourself by putting away the same amount.”
Prepaid plans should be simpler than Social Security because actuaries only have to estimate future tuition increases and investment returns. So, how have government actuaries done with this task? Not very well!
The New York Times reported that 16 of 18 prepaid plans are underfunded. But that’s not really accurate. The Times included Colorado’s plan as fully funded but the audited 2008 report actually shows a $1.5 million deficit. Maybe $1.5 million is close enough to break-even when dealing with other people’s money. Since the article appeared, some plans have released 2009 numbers showing even larger deficits. For example, Virginia reported a 2009 deficit of $284 million – five and a half times more than the $51.8 million 2008 deficit.
But the plans are guaranteed, right? Wrong! Many plans are only backed by the assets they hold. Does that mean that families whose kids go to college first win? That sounds like a Ponzi scheme that would send anybody but a government worker to jail.
Other states like Illinois have “legislative guarantees.” Imagine asking Illinois politicians to voluntary increase their state’s $8.75 billion deficit. Four states – Florida, Massachusetts, Mississippi and Washington – do guarantee their plans. However, Social Security was not the only government program to break a promise about “the most you will ever pay.” Texas used to be on the list of guarantee states until it decided it wasn’t. Now, students who don’t attend a Texas public college won’t get equivalent tuition to use at another school. Instead, families will get back their deposits, less a service fee.
In this economy, I guess Texas parents should be grateful that accounts are guaranteed only to decline by the amount of the service fee.
http://www.ssa.gov/history/ssb36.html (Text of the original brochure announcing Social Security)
http://www.nytimes.com/2009/10/05/education/05college.html?_r=1
http://www.virginia529.com/Documents/UNAUDITED_annual_report_2009.pdf