In a blow to parents already panicked about their ability to save enough for their children's college costs, some of the safest-sounding college savings plans are foundering.
Several plans marketed by states as "guaranteed" to keep up with skyrocketing tuition inflation lost hundreds of millions of dollars in the markets' 2008 meltdown. At least two state plans—in Alabama and Texas—could soon end up paying out less than parents and students had expected, revealing the surprising flimsiness of many of the "guarantees."
To add insult to injury, investors have little recourse, since a loophole exempts most of the state-sold prepaid tuition plans from most investor-protecting rules and watchdogs.
- Alabama's Prepaid Affordable College Tuition (PACT) has stopped accepting new investors, and a recent study revealed that it currently has only enough money to meet its promises through 2014. That's a problem because many parents and grandparents of toddlers had invested to guarantee tuition as far ahead as 2030. State officials are now debating how to make up a deficit of several hundred million dollars.
- The Texas Guaranteed Tuition Plan has announced plans to reduce the payout it will make to parents whose children don't go to Texas's public colleges. The TGTP, which was founded in 1996, promised that investors could withdraw the equivalent of current tuition rates when their student turned 18. But starting November 1, investors who want to cancel their plans will get only what they paid in, minus an administrative fee. Students who do end up attending public colleges in Texas will get the full value of their tuition, however, the state says. The state is no longer accepting new investors to that plan but is now offering a different prepaid tuition plan backed by participating schools.
- Pennsylvania's Guaranteed Savings Plan has also reported it is hundreds of millions of dollars short of its obligations for the next 18 years. One state legislator, Jeffrey Piccola, has floated a bill that would remove the word guaranteed from the name and require the state to inform investors that the state is not obligated to bail out the fund.
- A recent study by a college savings industry consultant showed that three states' prepaid plans—those in Illinois, Maryland, and Virginia—have "legislative" guarantees. That generally means the plan administrators will ask their state legislatures for a bailout if they need money. The consultant, Andrea Feirstein, says this language essentially imposes a moral obligation on legislators to bail out the funds, "which—to the best of my knowledge—in the history of the municipal market, has never been disregarded." But Mercer Bullard, an associate professor at the University of Mississippi law school, warns that legislatures are not legally obligated to provide cash and thus may balk at providing millions of taxpayer dollars "if it is in their political interest."
- Another five states' prepaid plans—those in Alaska, Michigan, Nevada, Pennsylvania, and Tennessee—are backed only by the assets of the plan. Alaska has buttressed its University of Alaska ACT Portfolio with an extra reserve and currently has more money than it needs to meet its obligations, says Jim Lynch, as associate vice president for finance for the University of Alaska and administrator of the guaranteed tuition savings plan. But other states are counting on a rebound in the investment markets to restore their funds in time to meet their obligations.
- Four other states—Florida, Massachusetts, Mississippi, and Washington—are backing their plans with the full faith and credit of the state itself. Of course, Texas offered that kind of guarantee for its TGTP but is nevertheless reducing the payout for some investors.
Two plans, the Independent 529 and the new Texas Tuition Promise Fund, are backed by the participating schools themselves.
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 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.