State College Savings and Prepaid Tuition Plans: A Reappraisal and Review
Posted: 11 Mar 2004
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 18 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 re-directs 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.
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