'Guaranteed' College Savings Plans May Soon Break Promises

Loopholes allow states to provide college savers with less-than-solid guarantees

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Publicly sold mutual funds and other investments are required by federal securities laws to make the names of the funds match the underlying investments and to provide investors with lots of information about the market values of their portfolios. But state-run funds, such as most prepaid plans, are exempted from all but the most basic antifraud federal laws. Some private attorneys have filed lawsuits against Alabama's prepaid plan in an attempt to make sure the fund pays all its promised obligations.

The general problem is that states offered "too good of an investment" to parents when they guaranteed to match tuition inflation, which has been rising faster than general inflation and faster than investment returns for the past several years, says Blake Fontenay, spokesman for the Tennessee Treasury Department, which runs that state's prepaid college savings plan. Although the final 2009 fiscal year accounting hasn't been finished, the recent rebound in the investment markets probably hasn't been enough to bring the Tennessee fund's assets up to the level needed to pay all its tuition debts for the next 18 years. "The problem is that it is not sustainable without some changes. Everybody here realizes that," Fontenay says.

Those potential changes are what concern investors and observers such as Bullard, the University of Mississippi associate law professor. "States are going to do what is in their political interest," he notes. In some cases, that could involve saving taxpayers money by disappointing a few thousand parents and children, he worries.

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  • Corrected on : Corrected on 10/05/09: An earlier version of this article incorrectly attributed comments about the security for three prepaid tuition plans to a report by an industry consultant. The analysis of the quality of the guarantees was made by other experts, such as the University of Mississippi's Mercer Bullard.