College Prepayment Programs Receive Mixed Grades

They promise big savings but have more restrictions than 529 savings plans and many state programs have struggled.

By Ed Prince

Like millions of Americans, Bob Cole faces the daunting prospect of paying for his two children’s future college education in a world where tuition increases have outstripped inflation for decades.

In 2000-01, the average annual rates charged for attending four-year institutions was $12,922, according to the National Center for Education Statistics (NCES). In 2021-22, that figure—including tuition, fees, and room and board—had increased to $30,010.

But the cost is even greater for families like Cole’s, who plan to send their kids to a private institution. The average annual sticker prices for those colleges and universities increased from $21,856 in 2000-01 to $47,962 in 2021-22, according to NCES.

With a son who is 10 and a daughter who’s 13, Cole expects the costs of the already-pricey private schools they are interested in to only get pricier. That’s why he’s enrolled them in Private College 529 Plan, a one-of-a-kind non-state program that allows parents to pay for their children’s future college education now and lock in the price of tuition and fees at the current rate.

Cole says that for families in a certain income range whose children will likely attend a private institution, Private College 529 could be a good fit.

He should know. He’s the president and CEO of the company.

As its name suggests, Cole’s company is the private college version of prepaid tuition programs offered by some states under the federal 529 tax law. The 529 law also includes the popular 529 savings (investment) plans that provide tax advantages to families and are offered by all 50 states.

Some college experts are more enamored with 529 savings plans than their prepaid cousins, and we’ll share why in a bit.

State prepayment programs in trouble

The number of states that offer the prepayment option has plummeted from 22 to just nine: Florida, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas, Virginia and Washington.

Many of the state 529 prepayment initiatives have floundered because of a key difference in the two types of 529 plans. In savings plans, families make their own investment decisions and save what they can for their children’s college education. But in the prepayment programs, states do the investing to provide full tuition payments once a student enrolls. That’s hard to do in a world where tuition regularly increases faster than the rate of appreciation on safe investments.

Maryland is a case in point. The state’s 529 prepayment program, Maryland Prepaid College Trust, which manages approximately 31,000 accounts totaling $1.1 billion, fell into financial disarray. The Maryland legislature reorganized the program and closed it to new accounts in June.

Meanwhile, Virginia, which had closed its prepayment program to new accounts, enacted reforms and reopened the program under new rules this year. But most states offering prepayment programs have permanently closed them to new accounts because of the financial pressures inherent in the model.

Only some states are legally obligated to guarantee the money that families pay into state-sponsored prepaid tuition plans. “If your prepaid tuition payments aren’t guaranteed, you may lose some or all of your money in the plan if the plan’s sponsor has a financial shortfall,” according to the SEC.

Private College 529’s guarantee

Cole says Private College 529 Plan differs from state programs in a way that allows it to grow while others have closed. Participating private colleges and universities agree to accept whatever money is in the accounts of families that have made their full tuition prepayment. So, if a family’s account balance decreased because of a market downturn, the institution will accept that amount as full payment, he says, noting that Charles Schwab is the custodian of Private 529 accounts.

“We have about $350 million in underlying assets in the plan, and an interesting thing about this plan is that the schools guarantee the tuition,” Cole explains. “So, if that $350 million went to zero, the schools are still covering the cost of education for it. … The schools guarantee that.”

“In a market that’s been very uncertain, that’s relieving to me,” Cole says, citing his own family’s use of the program. “And it’s certainly relieving to families to know that they have something in down markets that’s … sort of recession proof.”

Another plus for Private College 529 is that it offers a much wider selection of institutions, Cole says. State prepaid tuition programs are limited to eligible in-state institutions. One of the most popular, Florida Prepaid College Plan, serves 28 Florida colleges and 12 state universities. The Nevada Prepaid Tuition Program has only eight participating schools.

In contrast, the Private College 529 consortium currently consists of 295 participating private schools, including “flagship, premier, private colleges like Emory, Baylor, Stanford, Rice, MIT, Princeton, and Caltech,” as well as many small and medium-size private schools, Cole says.

“Our big push over the next year or two is to add another 50 colleges,” he says.

Private College 529 got its start in 2003 when a group of private secondary education institutions formed a consortium to create a 529 prepaid tuition program similar to those offered by states. Originally called Independent College 529, the program was renamed Private College 529 and has recently undergone another rebrand, adding the umbrella name CollegeWell. The new CollegeWell.com website offers information on the program and paying for college in general.

“One of the challenges that we found was that a lot of families, especially younger savers, hadn’t made the determination whether a private college or a public university was the right fit,” Cole says. “CollegeWell, it’s really an educational-focused website which has all the resources any family would need, whether they were going to go to public or would even go to private college.”

Prepayment programs face criticism

Meanwhile, critics contend that 529 college prepayment plans have serious drawbacks.

One is that a child enrolled in a prepayment plan may choose to attend a school that does not participate in that program. In that case, the family can get back the money it paid into the program but loses most of the interest that has accumulated in the account.

But Cole says a number of other options are available.

“Because it’s a 529 plan … a family could change the beneficiary. So, if, for instance, there are multiple kids, you could switch from child one to child two. You could roll it over to another 529 plan,” he says. “And then the third thing is you could take a qualified refund, which you could do with any plan, and as long as it’s used for educational expenses, there’s no penalty.”

But Cole concedes that prepayment plans have a drawback: They are good only for tuition and required fees. That’s why he recommends doing what his family has done: open a state 529 savings plan to cover other expenses, like room and board.

“I use MEFA here in Massachusetts, the Mass. Education Finance Authority,” he says, citing the state 529 savings plan he’s opened in addition to his children’s Private College 529 accounts. “My goal is that I will have resources in both so that I can cover some — and I probably won’t be able to cover all — of my children’s educational expenses.”

He offers a further word of caution — one that he acknowledges applies to his children: Enrolling a child in Private College 529 Plan doesn’t guarantee them admission to their college of choice. Students still have to earn admission the old-fashioned way, by getting the grades.

“You don’t need to commit to anything,” he says of families entering the program. “But you have to be accepted. Just because you’re saving in the plan doesn’t mean that you can get into Princeton or Stanford.”

National expert enumerates faults

Not everyone is sold on the benefits of college prepayment plans. Mark Kantrowitz, an authority on college finances for families, faulted both Private College 529 and the state prepayment programs.

“They are trying to sell you peace of mind, that if you buy your tuition now, it’s always going to be worth a year’s tuition,” Kantrowitz says.

But most people don’t do a lump-sum prepayment of an entire year of tuition, instead stretching out payments over time and diluting the prepayment savings, he says.

Jonathan Sparling, vice president of strategic partnerships and member relations for Private College 529 Plan, notes their plan doesn’t require parents to pick a college to prepay for, so the percentage of tuition that will be covered can vary.

“For example, if Nancy contributes $10,000 to her account for 8-year-old Ben, that equals a third of a year of tuition at College A where current annual tuition is $30,000, and a quarter of a year at College B where current annual tuition is $40,000,” Sparling said. “No matter how much tuition increases at Colleges A and B, Nancy will always own these percentages of tuition (33.33% at College A and 25% at College B) in the future.  Since we have 295 colleges in the plan, the same percentage principal calculation applies to all colleges.”

Kantrowitz said there’s another problem with state programs: They may charge a premium to cover the anticipated shortfall between the likely return on investment and the actual future cost of tuition.

Putting money into a state prepayment plan is risky because of the possibility the program may get into financial trouble, he says. “Several of the prepaid tuition plans have run into actuarial shortfalls, and what typically happens is they close the plans to new investment, including from existing families. They may then freeze the benefit as of a particular point of time. And so, you’re not getting that future college costs, you’re getting something less.”

“So, I don’t recommend them. Especially since they’re only available for tuition, not for full college costs. You can only use them to pay for tuition and fees, and you’re mainly getting the benefit if your child is going to enroll in state public college, but not everybody does that,” he says, referring to the state programs.

Another drawback is that the state is in charge of investment decisions, unlike 529 savings plans where the family makes the calls, he notes.

“You don’t control how they invest the money. Yes, they are supposed to be investing the money in a smart manner that minimizes risk. But if they were doing that, their average annual return on investment in a risk-adjusted investment would be only 4% or 5%. And college tuition often goes up faster than that, especially at public colleges,” Kantrowitz says.

Public colleges go through “feast-famine cycles” that can result in double-digit tuition increases, he says.

“What some of them have done is take on a riskier mix of investments,” Kantrowitz says of state prepaid tuition plans. “There was one that even invested in hedge funds. And then, instead of making up the difference, they lost even more.”

“So, I recommend that people focus on the 529 college savings plans, where you can control the risk, and nobody’s going to come in and say, ‘All the amount of money that you’ve contributed here, you’re not getting that. You’re not getting what you thought you saved.’ The promise is that you’re going to have it all taken care of, but oftentimes, it falls short of that promise,” says Kantrowitz, who notes that he has opened 529 savings accounts for his own children.

But Cole of Private College 529 says that plan is a good choice for families in a certain income bracket — those whose income is too great to qualify for financial aid, but not enough to pay for the entire cost of a college education at once.

“Our sweet spot will be those families that aren’t eligible for financial aid, which is typically $125,000 to $150,000 family income and above,” he says.

“So, if the bill comes due, and you’re able to pull out a checkbook and write it, this plan isn’t necessarily for you.”

Start investing early or wait and see?

Starting your children at an early age with Private College 529 can result in huge tuition savings, Cole maintains.

“We have an account owner who started in 2004 and put in $100,000 … per kid,” Cole says of a father of two. “And at the time, the school was about $25,500 a year. He bought four years. Right now, that school for both kids would have cost him a little less than $600,000. So he got himself a record deal.”

So, when should you enroll your kids in a prepayment plan? As early as possible, Cole maintains, citing his own family as an example.

“We started saving right when the kids were about 1,” he says. “I’ve now got a 13-year-old, and I’ve got a 10-year-old. I’ve got a pretty good mix of all savings and prepaid tuition at this point. My goal, when the kids get ready, I would love to have two years covered for each of the kids. And then I would end up having to probably use other means, whether it’s borrowing or other, to be able to cover the rest.

“But really, it’s like saving for retirement. The earlier you do it, the better off you are. You’re able to contribute more over time because you’re starting earlier,” he says.

Not everyone agrees with Cole’s “early as possible” advice.

Amy Irvine, CFP, with Rooted Planning Group in Corning, N.Y., has referred clients to Private College 529, but says parents should wait until they have a good idea of their child’s academic potential.

“If you have saved diligently in a 529 savings plan and it is clear in 8th or 9th grade that your child is going to be academically strong and likely to go to a private college, that is (a) time the product would be appropriate — lock in the cost four to five years early. This allows parents to be aggressive on the investing side early, and lock in the credits early,” Irvine writes in an email.

Cole acknowledges that it may be difficult for young families to put much money away for college. That’s why they should get relatives, particularly grandparents, involved, he says.

‘Not a fan of single-purpose dollars’

Beth V. Walker, a wealth advisor with Carson Wealth in Colorado Springs, Colo., says she has had clients who started their kids in a prepayment plan early.

“I had several clients in Nevada and Florida that used the prepaid plans,” Walker writes in an email. “The parents assumed the kids would go in-state when they set them up (usually done when the kids are very young) and they liked the ‘certainty’ of being able to have four years of college (tuition only) paid for.”

But Walker has reservations about putting all the eggs in the prepayment basket.

“With the accelerated rate of change in today’s world, I’m not a fan of single-purpose dollars most of the time. Hard to say what the landscape will be in five, 10, 20 years for college in America. I am a fan of saving money for the down payment on the college purchase and doing that in the most tax-efficient manner, but I try to balance that with liquidity, use, and control of capital.  So much depends on the family circumstances,” she writes.

Walker says prepayment appeals to certain families and agrees with Cole that families should ask for help with paying into a prepayment plan.

“In my experience, prepaid plans are most often used by parents that are ‘early planners’— it’s well-defined, and the outcome is more certain. That said, it would still not be my ‘go to’ recommendation due to the single-purpose nature of the money. This might be an easier way for a grandparent to set aside money for college, so I would give this consideration if there would be that possibility.”

In a four-decade career in journalism, Ed Prince has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune.

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