How Safe Is Your College Savings Account?

Many college savings plans have been hammered by the same kinds of investment bubbles and scandals that other investment plans have faced in the past year, causing thousands of Americans to halt their contributions to college savings and a few to file lawsuits alleging they were misled.

But a few glimmers of hope are emerging for those planning for a college degree. Congress is mulling a bill that would give many savers tax breaks, and some states are slowly tinkering with their portfolios to replace risky strategies with safer alternatives. And experts hope the losses have taught parents to check out the safety of all of their portfolios, including college savings. Experts such as Morningstar, Savingforcollege.com, and Consumer Reports analyze the investment mix of college savings plans.

These improvements and hard-learned lessons are scant comfort, however, to tens of thousands of savers who put money in such investments as:

• Oregon's "Conservative" 529 option, which lost more than 30 percent of its value in the 12 months that ended March 31 because OppenheimerFunds put some of the money into derivatives.
• Pennsylvania's "guaranteed" college savings plan, which promised parents their contributions would grow at the same rate as tuition. But the state recently informed parents that the guarantee actually is only backed by the fund itself. Because of the stock market crash, the fund now has enough money to pay college bills only for the next eight years, even though some families invested in the hopes that their young children would be protected 10, 12, or even 18 years from now.
• Alabama's PACT, which encouraged parents to plunk down money years ahead of time to lock in a share of tuition at the state's public universities. Alabama's Prepaid Affordable College Tuition program now says it has enough money to cover students' tuition only for the coming academic year. Younger children's prepaid tuition will be covered only if the markets bounce back soon, or the state government bails out the fund.

"A 'pact' is a solemn agreement or contract," fumes Todd McLeroy, an attorney in Cullman, Ala., who prepaid four years of tuition for all three of his children years ago. His oldest is now 15, and the fund might run out of money before McLeroy's first college bill arrives. McLeroy has sued Alabama on behalf of another investor, complaining, among other things, that the fund lost more than 50 percent of its money because it took too many investment risks.

Analysts say that investors in many other state 529 plans—which are named after the section of federal law that created the state-sponsored, tax-protected college savings accounts—have suffered similar, though often smaller, losses.

Little wonder, then, that investors across the country appear to be pulling back on their contributions. (According to a new national survey conducted by Gallup and Sallie Mae, the current recession has caused 48 percent of parents of collegebound students to decrease their college savings or not save at all.) The 529 industry reported taking in a net of $1.6 billion in the first quarter of 2009, down from $2.1 billion a year ago. During last fall's big market drop, investors pulled more than $3 billion from their college savings accounts.

That's a shame, says Rep. Earl Pomeroy, a North Dakota Democrat. Pomeroy is pushing legislation that would give big federal tax credits to low- and middle-income families who sock away money for college, creating a federal match similar to those some employers offer workers who contribute to 401(k) savings accounts. The painful losses "have made us sadder but wiser investors. But the answer is not to forget about savings. It is more important than ever," he says.