State college savings and prepaid tuition plans: A reappraisal and review

Journal of Law and Education, Oct 2003 by Olivas, Michael A

ABSTRACT

The growth of state prepaid plans and state savings plans (529 plans, named for the IRS Code section) has been nothing short of phenomenal, with several states having billions of dollars in their 529 reserves, and a number of states selling tens of thousands of contracts each year. Florida's prepaid plan is among the nation's premier programs, with over 750,000 beneficiaries and almost $5 billion in assets. Every state now has a savings plan, and eighteen have both a saving plan and prepaid plan. This growth, spurred by generous federal tax legislation, has brought exceptional professionalization into play, with several national financial organizations such as TIAA-CREF, Fidelity, and others providing services to states. The advantageous tax treatment has given rise to many states offering multiple programs with generous provisions and helpful features.

That said, a number of policy issues have surfaced, including federal tax treatment of the plans, financial viability during unstable economic periods, system complexity that makes it difficult to evaluate plans or comparison-shop, and understanding the proper role of states in a federal financial aid system. For example, a number of states have privatized these programs, setting up shops with turnkey elements. A small number of states have given full faith and credit protection to 529 plans, raising the possibility that a state's general fund resources will be used to bail out losing programs.

Several issues of state and federal taxation remain unclear, such as how 529 plans "count" in federal aid determination, and why gains on prepaid plans are included in the Expected Family Contribution, while proceeds from savings plans are not included in the EFC. Until Congress extends the 2011 sunset provision, parents or other potential purchasers may be reluctant to purchase 529 plans, even though it is likely that Congress will act to extend the tax treatment before that cutoff date.

Finally, there remain important equity, institutional, and legislative policy implications. Among these are the extent to which these plans exacerbate the gap between the well to do and the financially-needy, the extent to which prepaid plans will distort the admissions process and need-blind financial aid/admissions, and the likelihood that enormously successful 529 plans may restrict needed tuition increases or trade off against legislative appropriation levels. There is evidence to support all these equity concerns. Additional questions that have not been addressed include the extent to which generous tax treatment actually stimulates additional family savings for college, or simply redirects family investment strategies. At the end of the day, prepaid plans are popular vehicles for the more advantaged, but their success has within it a number of policy concerns that deserve attention by scholars, legislators, and families.

I. INTRODUCTION

If college savings plans (CSPs) did not exist, someone would have to invent them. As I travel through various states, I almost get a lump in my throat seeing public service ads for CSPs on late night television. Texas has one that features a pretty young Mexican American, who asks her mom if she will be able to go to college-fade to a Florida family standing around a cake, celebrating a grandchild's birthday, complete with prepaid tuition certificates as popular birthday gifts-fade to another state's public service announcement that I think is for its lottery, when it is revealed that all the hullabaloo is about the new prepaid tuition plan. Certain ticket holders even will receive scholarships-yet another state will give fully paid CSP awards to the first five children born in the upcoming year-I find myself mentally backdating nine months from the due date, and realize I missed out.

By the end of 2002, every state plus the District of Columbia has a CSP, either the prepaid version, in existence since the 1980s, or a pooled-investment savings trust program.1 Several states have both, prompted by the 1996 legislation that created 529 plans, named after their IRS tax code provision.2 The prepaid plans, operational in twenty states, work on a very simple premise: parents or grandparents place a lump sum in a contract (or they make monthly payments) that guarantees the money will be sufficient for an equivalent of tuition and fees in a set period of time in the future. Thus, if 2003 tuition at a Texas public college is $10,000 for each of four years, that $10,000 (plus a small fee) invested in the Texas Tomorrow Fund (TTF) in 2003 will be guaranteed to cover my newborn daughter's four years of tuition and fees in 2021-eighteen years from now. The state can guarantee the return by virtue of pooled assets, economies of scale, and careful actuarial practices. Some states even assure the full-faith-and-credit (FF&C) of their state (Texas being one) to these plans, pledging state funds to cover any eventual shortfall.3 In other states, you take your chances with the markets.