529 Prepaid Tuition Plans Overview
Prepaid tuition plans are state run plans that allow savers to lock in future tuition costs at today’s rates. Currently there are only 9 states running prepaid tuition plans. These prepaid tuition plans work like an insurance product. You give money to the state to invest on your behalf and in return they promise to give you money back in the future to cover presumably higher tuition.
That promise is only as good as the state or program making the promise. The plans invest the funds collected from savers, which carries the risk that future tuition rates could outpace the investment returns earned by the plan. While this hasn’t historically impacted most savers, there are plans under duress. At 6/30/20, Illinois reported assets in their program of $589M against liabilities of $928M, giving them a funded ratio of only 63.4%. If the state doesn’t kick in additional funds in the future, current savers will not receive the full tuition payments they were promised.
The idea of locking in future tuition rates sounds appealing when so many have heard of the skyrocketing tuition rates over the past few decades. However, the reality is that most savers would end up with much more money if they invested their money in a regular 529 education savings plan or an educational savings account rather than a prepaid plan. Over the past two decades most reasonably constructed investment portfolios have handily beaten the inflation rate of college tuition.
It’s important to do your due diligence on your particular state’s plan if you are considering a prepaid tuition plan. What is the plan’s funded ratio? Is it backed by the full faith and credit of the state? What future costs are covered? What if the child moves out of state? Each plan has its own rules and features that you should take into account.
Here’s a look at Washington’s plan:
Washington State’s Guaranteed Education Tuition (GET) Program
GET is Washington State’s prepaid tuition plan. To participate in Washington’s plan, either you or the student must be residents of the state at the time of enrollment. The enrollment period is between November 1 – May 31 with year round enrollment for newborns.
To invest in the plan, GET account holders buy units equal to 1/100th of the undergraduate tuition rate at the State’s most expensive public university. Thus 100 units will pay for one years tuition at any public university in the state. A student can have up to a maximum of 800 units purchased on their behalf. The highest annual tuition rate in the state for 2021-22 is $11,401, thus the current unit value is $114.01.
Traditionally, units have traded at a premium to the current unit rate value. For the first time in program history, the current unit cost is equal to the payout value at $114.01. The WA529 Committee (GET’s governing committee) sets the unit purchase price with the input of an actuarial formula that takes into account estimated future tuition, projected inflation and investment returns, and administrative costs.
The historical unit value and tuition costs are shown in the first chart below:
Here’s a look at the unit cost over time:
Washington’s GET program funded status
At 6/30/20, Washington State’s GET program was in strong financial health with a funded status of 131%. The State reported assets of $1.67B against expected liabilities of $1.19B. This was nearly unchanged from the position at 6/30/19, when the program’s funded status was also 131%.
Washington State tuition inflation rate
Washington State’s Legislature passed the College Affordability Program (CAP) in 2015, which mandated that annual tuition increases may be no more than the state’s average annual growth in median hourly wage beginning in the 2017-18 academic year. This may help cap tuition increases in the state which makes the prepaid option potentially less attractive.
Qualified education expenses and out of state schools
Washington’s GET program units can go toward any qualifying educational expenses. The definition the state uses is the same as the federal definition and therefore may include things like room and board and books in addition to tuition.
If the student attends college out of state the units may still be used to help pay for those educational expenses (although you’d only receive the current value of the units and be on the hook for the difference between the more expensive out-of-state tuition cost and the in-state units).
Just like other 529 plans and ESA accounts, prepaid accounts are considered assets of the parents and treated favorably for financial aid considerations.
What if my student doesn’t attend college?
You have up to ten years after a student reaches college age to begin using your GET account. These funds are transferable to another family member. Otherwise, the funds can be withdrawn but you will pay a 10% penalty on earnings in addition to taxes.
HIstorically most savers would be better off utilizing a different savings vehicle to pay for their students future education. For those worried about poor future investment returns or skyrocketing education costs they may want to consider their state’s prepaid plan as part of their overall college savings strategy. However, it’s important to look at the particular rules and funded status of your particular state’s plan (assuming it has one at all).
If you have any questions or would like to talk about your college savings plan please feel free to reach out to me.
Scott Caufield, CFA, CPA