When Washington state officials announced that they were freezing the state’s popular prepaid college savings plan, Heather Hewson Rock was among thousands of investors faced with the same decision: Keep the money in or take it out?
She bought into the Guaranteed Education Tuition plan, called GET, about six years ago on behalf of her 7-year-old twins and 13-year-old daughter. The program, like other prepaid plans, offered the opportunity to buy future tuition credits at prices close to current costs.
“It looked really good to start with,” says Rock, a senior vice president with Baird Financial Advisors in Seattle. “It was a good price. It’s backed up by the state of Washington. We were very comfortable with the promise.”
But when the Washington state legislature cut tuition at the state’s public colleges earlier this year, GET administrators froze the value of tuition credits for two years and halted the opening of new accounts.
Washington’s prepaid program is not the only one to struggle. Tennessee’s prepaid college savings program, the Baccalaureate Education System Trust, or BEST , program, will formally terminate on Nov. 30. Tennessee follows at least eight other states in locking out new investors or closing plans completely. Nearly a dozen states still have prepaid plans, in addition to one existing prepaid plan for private colleges.
When a college savings plan shuts down or closes to new accounts, investors are often given the choice of leaving their money in the plan or withdrawing it. Here are some factors to consider.
[Avoid these common prepaid tuition plan mistakes.]
— How diversified are you? Rock says she’s planning to keep her money invested in Washington’s GET program, largely because she isn’t relying on it to completely fund her children’s college educations. She and her husband purchased about two years’ worth of credits for each child, but all three also have trust accounts set up with money intended for their educations.
“Our daughter has five years to university, and our two boys have 11 years,” she says. “If we have (the GET credits), and the other money is diversified mostly into equities, for us, that’s a balance.”
— Is there a state guarantee? Washington’s plan is backed by the “full faith and credit” of the state, meaning that if future tuition increases require the program to pay out more money than it has available, the state legislature would have to provide funds to make up the difference. Tennessee’s plan, on the other hand, is not.
Rock is banking on Washington’s guarantee. After the two-year freeze is up, she assumes tuition will rise again at Washington state schools, which means the value of the credits she purchased will go up with it.
“The GET plan is tied to the cost of a credit at the most expensive Washington public college,” she says. “If they raise the cost of tuition at those colleges, they will have to raise the value of a unit.”
Shelli King, communications director for the Tennessee Department of Treasury, says the board of trustees for Tennessee’s BEST program will continue to set the value of the program’s units based on the weighted average tuition at the state’s public schools. However, investors in Tennessee’s BEST program only have the option of keeping their money in the plan if the beneficiary will graduate high school within three years of the termination date of Nov. 30, 2015. The rest will have to take a payout or roll the money over into another account.
[Explore the do’s and don’ts for using a prepaid tuition plan.]
— How old is the student? Beneficiaries who are nearly college age may want to sit tight and keep their money invested in a defunct or frozen prepaid plan if they can, especially if they’re planning to attend an in-state school.
“If someone’s in high school, and if they know with some certainty they will be going to a public institution in that state, then yes, it’s a really good value, simply because of the locked-in tuition growth,” says Peter Mazareas, past chairman of the College Savings Foundation and the former executive director of the Massachusetts Educational Financing Authority.
Investors with children who haven’t started high school yet should consider rolling the money over to another tax-advantaged 529 college savings plan, especially if the prepaid plan is not guaranteed by the state, Mazareas says.
— Could you face penalties? Most states permit investors to roll the money over into another 529 plan without any penalties, Mazareas says.
If an investor chooses instead to take a withdrawal and does not use the money for qualified education expenses, he or she would have to pay a 10 percent penalty plus income tax on the earnings.
“The cleanest thing for families in that situation would be a rollover to a traditional 529 savings program as opposed to a prepaid program,” Mazareas says.
[Know the college savings pros and cons for financial newbies.]
There may be a limit to how long consumers have to reinvest the money in another 529 account. In Washington, GET investors can pull the money out until December 2016 without incurring state penalties, but they must reinvest it in another 529 account within 60 days.
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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