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

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

This system complexity can become a barrier to market entry for some. The early state prepaid programs did not pose this issue, as purchasers simply bought into a contract that either performed well or did not, and in states with guaranteed state FF&C, the investment results literally made no difference to the purchasers (save for their concern about overall program efficacy, as in the Wyoming case). Consumers of state savings and trust plans, however, invest both for the substantial state and federal tax advantages, and for enhancing their investment returns. This lack of transparency is another result of system complexity and too many choices.

Yet another issue is that the range of investment options may have unintended consequences. Diverse plan options may encourage purchasers to place all their eggs in one basket. I have been concerned about the rise of single mutual funds as state options, both with and without brokers, in several state plans, such as those in Utah, Texas, and Nebraska.65 My concern is that many people in traditional marketplaces might choose mutual funds due to their broadly-based mix of stocks (or bonds, in some instances), when individual contract purchaser needs may be poorly suited for such vehicles. For example, a neutral fund will likely track the performance of the Dow-Jones or Standard & Poor markets, when an investor with a teenaged or middle school child will need to better today's disappointing market performance. Use of a single mutual fund may not be a well balanced choice for college going plans: college attendance will likely come soon after high school, whereas retirement age is subject to many features and can be postponed in real life. Joseph Hurley made this point dramatically in an October 2002 editorial to his service subscribers to the Savings College Plan Network,66 when he noted a similar concern in his Utah Educational Savings Plan, a single 100% equity mutual fund option, offered by the private Vanguard Institutional Index Fund.67 While he notes that he is, in principle, for "greater investment choice," he is also concerned that such options will lead parents to place all their CSP eggs in one basket, rather than diversifying across several options, especially age-based ones that shift their investment mix as the beneficiary approaches college age.68 No doubt, he was also influenced by the mutual fund's poor performance in 2001-02, when it lost over 30%,69 but his overall point is a good one, a situation exacerbated by system complexity. Whenever information, such as how to best allocate and invest in state programs, is at a premium, the persons least likely to participate or prosper are the less well educated, the poor, and minorities. Thus, system complexity in state prepaid and savings programs-even in states with low barriers to entry and monthly payment options-attract and reward the most advantaged and knowledgeable participants, much like the college application process itself, which so clearly serves the interests of advantaged and wealthier students. If information and investor savvy are needed for these dynamic investments, state prepaid and savings plans will widen the gap between wealthy and poor, majority and minority, street-smart and book-smart.