College 529 prepaid tuition plans at risk

Do due diligence

Families enrolled in plans that aren't guaranteed shouldn't automatically assume their money is in jeopardy, says Karen Duddlesten, Nevada's senior deputy treasurer. Nevada's prepaid program isn't backed by the state; however, the plan remains in good standing thanks to a 100 percent increase in enrollment this past year as well as a healthy level of savings the program accumulated in fiscally brighter times.

Duddlesten says parents should ask what happens to the plan in the case of monetary emergency.

"You need to ask how long the program's been around, what their anticipated rate of return is, what kind of tuition increases they're expecting, how the board manages investments and how much they've built into the formula to stabilize funds in case bad times happen," she says.

Examining how a prepaid plan will operate 15 years or 20 years down the road also means looking at the ratio of cash going out versus available funds, she says. While some programs are barely squeaking by with ratios of 50 percent or less -- paying out $2 for every $1 in cash on hand -- stronger programs like that of Nevada are still operating at 100 percent, even without a state-backed guarantee.

Besides the influx of new enrollees, the health of Nevada's program can be measured by the amount of funds in cash reserves -- anywhere from 20 percent to 30 percent, depending on the year.

"Parents should be looking for at least a 15 percent reserve in any plan they enroll in," Duddlesten says. "They need to know that the board operating the plan is making reasonable and attainable assumptions for the future."

Demand transparency

Andrew Davis, executive director of the Illinois Student Assistance Commission which operates that state's 11-year-old prepaid plan, says that when it comes to investing -- whether in a 529 program or otherwise -- investors should always demand transparency.

"Families should ask to see a plan's financial statements," he says. "Each month we publish an updated report on the investments we have on our Web site so people can gauge the financial strength of the program. There are also actuarial reports by an outside party to provide families with objective data."

The Illinois plans' most recent actuarial report, performed by PricewaterhouseCoopers, shows the fund down by $273.2 million, but Davis says it should be able to pay full benefits through 2021. He adds that this figure is based on conservative fiscal assumptions, including a 9 percent increase in tuition each year, despite the fact that tuition at Illinois public institutions only increased 5.3 percent last year, according to the College Board. It also assumes zero returns on investments for the next nine years and no new enrollees.

"It's a worst-case scenario kind of estimate," Davis says. "Even if absolutely everything in our plan fails, we can still cover benefits until 2021."

Davis also adds that examining a program's fiscal assumptions is crucial in evaluating how well-funded the program is. While Illinois is only about 75 percent funded based on a 9 percent tuition inflation estimate, it's actually performing comparable to Florida's prepaid plan, which is currently 100 percent funded but only assumes a 6.5 percent annual tuition inflation rate. This past fall, all of Florida's public four-year institutions increased tuition by 15 percent.

Diversify investments

Even after doing due diligence, families that enroll in a plan that isn't backed by the state or state institutions are still at risk of losing their tuition credits if the market takes a sudden plunge. One way to mitigate that risk is to diversify your investments, says Duddlesten, by putting some money in 529 savings plans that can help pay for other college expenses such as dorm fees and books. In these savings plans, parents can control their risk exposure by choosing from among conservative and aggressive funds.

Pulling funds out of a prepaid plan altogether can be expensive. According to the Securities and Exchange Commission, unless the beneficiary receives a lucrative scholarship, withdrawing funds from a prepaid plan for anything other than tuition, death or disability will cost you 10 percent of all plan earnings, plus you'll have to repay any federal or state income tax deductions you've taken for the plan over the years. An alternative: Funds can be rolled over into a 529 college savings plan without penalty.

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