College Savings: Information on State Tuition Prepayment Programs
(Chapter Report, 08/03/95, GAO/HEHS-95-131).
--------------------------- Indexing Terms -----------------------------
REPORTNUM: HEHS-95-131
TITLE: College Savings: Information on State Tuition Prepayment
Programs
DATE: 08/03/95
SUBJECT: State-administered programs
Tax credit
Colleges/universities
Disadvantaged persons
Higher education
Aid for education
Education or training costs
Advance payments
IDENTIFIER: Michigan
Alabama
Alaska
Florida
Ohio
Pennsylvania
Wyoming
Michigan Education Trust
Census Bureau Current Population Survey
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Cover
================================================================ COVER
Report to Congressional Requesters
August 1995
COLLEGE SAVINGS - INFORMATION ON
STATE TUITION PREPAYMENT PROGRAMS
GAO/HEHS-95-131
State Tuition Prepayment Programs
(104735)
Abbreviations
=============================================================== ABBREV
CD - certificate of deposit
CPI - Consumer Price Index
CPS - Current Population Survey
IRA - individual retirement account
IRS - Internal Revenue Service
MET - Michigan Education Trust
Letter
=============================================================== LETTER
B-254026
August 3, 1995
The Honorable Nancy Landon Kassebaum
Chairman, Committee on Labor and
Human Resources
United States Senate
The Honorable James M. Jeffords
Chairman, Subcommitee on Education,
Arts, and the Humanities
Committee on Labor and Human Resources
United States Senate
The Honorable Thad Cochran
United States Senate
In response to your request, this report presents the results of our
study of state tuition prepayment programs. These programs represent
one approach that some states have adopted to encourage families to
save for their children's college educations.
Copies of this report are also being sent to appropriate
congressional committees, the Secretary of Education, the
Commissioner of the Internal Revenue Service, and other interested
parties.
This report was prepared under the direction of Wayne B. Upshaw,
Assistant Director, who may be reached on (202) 512- 7006 if you have
any questions about it. Other major contributors are listed in
appendix IV.
Cornelia M. Blanchete
Associate Director, Education
and Employment Issues
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
In the 1980s, several factors combined to create the perception of a
college affordability crisis. From 1980 to 1987, the total cost of
college attendance increased by an average of almost 9 percent
annually, while median family income grew by an average of less than
6 percent. Also, student financial aid did not keep pace with rising
college costs, and the mix of aid changed from mostly grants to
loans, contributing to concerns about excessive student debt.
In light of these trends, government officials at both the state and
federal levels developed numerous proposals to encourage families to
save for college. A handful of states adopted a tuition prepayment
program, allowing parents or others to pay in advance for tuition at
participating colleges on behalf of a designated child and
guaranteeing to cover the child's future tuition bill at one of these
colleges, no matter how much costs rise. By allowing purchasers to
"lock in" today's prices, these programs are intended to ease
families' concerns about whether they will have sufficient funds in
the future to pay for their children's college educations.
The Chairman of the Senate Committee on Labor and Human Resources;
the Chairman of the Subcommittee on Education, Arts, and the
Humanities; and Senator Thad Cochran asked GAO for information on
state tuition prepayment programs. GAO agreed to (1) describe how
these programs operate and the participation rates they have
achieved, (2) assess participants' income levels and options for
increasing the participation of lower-income families, and (3)
discuss the key issues surrounding these programs. To address these
objectives, GAO reviewed the literature, interviewed key program
officials and other people knowledgeable about these programs, and
analyzed data on program participants and other residents of these
states.
BACKGROUND
---------------------------------------------------------- Chapter 0:2
In 1986, Michigan became the first state to create a tuition
prepayment program--the Michigan Education Trust (MET). At least a
dozen other states have followed Michigan's lead by authorizing such
programs, but only seven had implemented their programs by 1994:
Alabama, Alaska, Florida, Michigan, Ohio, Pennsylvania, and Wyoming.
The programs operate as follows. Purchasers pay in advance for
educational benefits that a designated beneficiary is expected to use
in the future at participating institutions, usually in-state public
colleges. The program pools all payments into one large fund and
invests it with the goal of achieving a rate of return that is higher
than the rate of tuition increases anticipated at participating
colleges. When the beneficiary enrolls at a participating college,
the program pays to the school whatever it charges at that time for
tuition and fees and any other prepaid expenses, such as housing
costs.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
Although the seven programs GAO studied all operate similarly, they
also have many unique features that distinguish them from one
another. Existing programs have also achieved varying overall
participation rates. The factors that program officials emphasized
as important for maximizing participation include (1) effective
advertising and marketing, (2) a positive public perception of the
program, (3) simple and flexible program features, and (4) affordably
priced benefits.
Most participants in state tuition prepayment programs come from
middle- and upper-income families; lower-income families are
underrepresented. When asked about the potential of two
options--sliding-scale fees and a tax credit--for increasing
participation among lower-income families, program officials said the
former option would pose too great an administrative burden, and some
questioned the effectiveness of the latter option. Although
officials have tried to make program benefits affordable for all
families, substantially increasing the participation of lower-income
families will probably be difficult, given their lack of
discretionary income.
Four major issues concerning these programs are (1) the potential
effect they have on students' educational choices; (2) their appeal
to mostly middle- and upper-income families, and the possibility that
such families receive subsidies through participation; (3) their
value as an investment for purchasers; and (4) the degree of risk
they pose for states. The most significant issue facing these
programs, however, is the potential applicability of federal tax
provisions. Nearly 8 years after the first state tuition prepayment
program started operating, questions remain unresolved about the
potential tax liability of purchasers, beneficiaries, and the
programs themselves. Officials are concerned because certain federal
tax consequences could make it difficult to operate these programs
successfully. Federal legislation could resolve this issue quickly
and favorably. However, certain factors would need to be considered,
such as the potential cost to the federal government in terms of lost
tax revenues and possible negative effects on private sector
institutions competing for college savings dollars.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4
STATES' EXPERIENCES IN
OPERATING TUITION PREPAYMENT
PROGRAMS
-------------------------------------------------------- Chapter 0:4.1
The seven programs GAO reviewed have followed two approaches to
selling prepaid tuition benefits. In Alabama, Florida, Michigan, and
Wyoming, purchasers sign contracts to pay for a certain type and
amount of benefits. In Florida, for example, purchasers can choose
among contracts covering 2 years at a community college, 2 years at a
community college plus 2 years at a state university, or 4 years at a
state university. With these programs, purchasers also typically can
choose between either one lump-sum payment or a long-term payment
plan. In Alaska, Ohio, and Pennsylvania, tuition benefits are sold
in small amounts, such as credit hours or even smaller units,
allowing purchasers to buy whatever amount of benefits they want at
any time. In addition to these two different approaches to selling
prepaid benefits, each state's program has its own operating rules
and unique features.
Existing programs have achieved varying participation rates. For
example, Florida's program has sold an average of about 37,000
tuition contracts per year, equivalent to 1.57 percent of nonpoor
children in the eligible age range. In contrast, Wyoming's program
has sold about 100 contracts per year, which is only 0.14 percent of
nonpoor children in the eligible age range.
One factor that program officials described as particularly important
for maximizing the total number of participants is an effective
advertising and marketing effort to reach potential purchasers. A
second key factor is developing and maintaining a positive public
perception of the program as a good way to save for college. For
example, sales in Ohio decreased about 60 percent last year after the
Governor questioned whether the program was a good deal for state
families. A third key to maximizing participation is having a
simple, flexible program. For example, after Florida's program
introduced more flexible rules on using benefits at out-of-state
colleges, tuition contract sales increased substantially. A fourth
factor officials identified is making program benefits affordable.
GAO's analysis found that annual program participation rates are
generally higher in states where tuition is more affordable to
average-income families.
PARTICIPANTS RELATIVELY WELL
OFF; LOWER-INCOME FAMILIES
HARD TO REACH
-------------------------------------------------------- Chapter 0:4.2
Most participants in state tuition prepayment programs come from
middle- and upper-income families. For example, in Alabama, Florida,
and Ohio, the majority of purchasers reported family incomes of over
$50,000 in 1992, while the majority of state families with children
had incomes under $30,000. In addition, Alabama state tax returns
from 1992 and 1993 revealed that the median income among purchasers
was about $61,200, while Bureau of the Census data showed the 1992
median income for all families in the state was about $27,400.
Significantly increasing participation among lower-income families
will probably be difficult. States have already tried to make their
prepaid benefits affordable; for example, some offer extended payment
plans. Also, officials said a sliding-scale fee system would be
administratively burdensome, and some questioned whether a tax credit
for lower-income purchasers would be effective, because it would not
solve the cash-flow problem these families would face in paying for
program benefits. Five states have developed plans to provide
prepaid tuition scholarships to needy students, but these efforts
generally have not lived up to their potential because of funding
constraints.
MAJOR ISSUES CONCERNING
STATE TUITION PREPAYMENT
PROGRAMS
-------------------------------------------------------- Chapter 0:4.3
One key issue concerning these programs is the effect they might have
on beneficiaries' educational choices. A common criticism is that
beneficiaries will choose to attend in-state public colleges, because
their prepaid benefits will fully cover tuition costs at such
schools, even though an in-state private or out-of-state college
would better meet their educational needs. GAO found evidence
suggesting that most beneficiaries may not believe their educational
choices are constrained. Specifically, (1) about 72 percent of all
freshmen students in the country enroll at a public college in their
home state and (2) some program beneficiaries--18 percent in
Michigan, for example--have used the value of their benefits to
attend nonparticipating colleges.
A second issue concerning these programs is that they appeal mainly
to middle- and upper-income families. Critics are concerned that the
programs could subsidize their mostly well-off participants, while
doing little to help lower-income families. Supporters say not all
programs have to help the poor, and that increased saving by
middle-income families may free up financial aid funds for
lower-income students. GAO found that these programs can involve
various subsidies to participants, such as tax advantages and
discounts on benefit prices. However, these programs can also
operate without providing these kinds of subsidies. In addition,
they likely will not free up substantial financial aid funds for
lower-income students.
A third issue concerning these programs is their value as an
investment option. Critics say purchasers could earn a better return
on their money through other investments, while supporters praise the
programs' simplicity, affordability, and the guarantee to cover
future costs. GAO found that while purchasers might earn a higher
return from other investments, such as stocks, many purchasers may be
too risk averse to invest in such options; for example, over 50
percent of purchasers in Alabama indicated that without the
prepayment program, they would be depositing their money in a
passbook savings account.
A fourth issue for these programs is the degree of risk they pose for
states. Critics worry that the programs could create an unfunded
liability for the state, while supporters claim the risk of a
shortfall can be minimized. GAO's review found that one state
suspended new sales several years ago when its program appeared
headed for financial trouble, but officials say the program is still
actuarially sound. In addition, if a program faced a shortfall, it
is unclear which of several possible outcomes might occur, and
whether they would be negative is a matter of opinion.
FEDERAL TAXATION MOST
SIGNIFICANT ISSUE
------------------------------------------------------ Chapter 0:4.3.1
The most significant issue facing states in establishing and
operating a tuition prepayment program is the possible applicability
of federal tax provisions to purchasers, beneficiaries, and the
programs themselves. This issue is important because certain tax
consequences could make it more difficult--perhaps even
impossible--for programs to survive. Concerns about taxation have
led some states to defer implementation of these programs.
Officials are most concerned about two potential tax consequences.
First, officials hope these programs are exempt from federal taxes on
their investment earnings, because paying such taxes makes it more
difficult to meet future liabilities. What it takes to qualify as
exempt, however, is somewhat unclear, in part because the Internal
Revenue Service (IRS) and a federal appeals court have disagreed on
the tax status of Michigan's program, and also because other existing
programs have not received guidance from IRS.
Second, program officials are concerned that IRS may decide
purchasers or beneficiaries are liable for federal income taxes
annually on the imputed interest earned from their investments in
prepaid tuition benefits. Until now, officials have followed
guidance that IRS issued for Michigan's program, which said that
beneficiaries are liable for taxes on the increased value of their
prepaid benefits at the time of redemption. Officials believe that
changing from a deferred to an annual tax would create an
administrative burden for their programs and a disincentive for
potential purchasers.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:5
GAO discussed a draft of this report with IRS officials, who agreed
with the discussion of federal tax issues. The information in this
report was also reviewed by officials from all seven state tuition
prepayment programs, who agreed with GAO's characterization of the
issues and descriptions of their programs. Where appropriate, GAO
incorporated minor wording changes suggested by IRS officials and
state program officials.
INTRODUCTION
============================================================ Chapter 1
As the cost of college rose faster than family income for several
consecutive years in the 1980s, many people became concerned about
the future ability of average American families to afford a college
education for their children. In response, both state and federal
government officials sought ways to encourage and help families to
save for college. One innovative approach, tried in a handful of
states, allows people to pay roughly current prices for tuition at
participating colleges in exchange for a guarantee that a child's
future tuition bill at one of these institutions will be covered, no
matter how high costs rise. These programs are known as tuition
prepayment programs.\1
Many other states started college savings bond programs for their
citizens, and the federal government created a tax advantage for
using U.S. savings bonds to pay for college.
--------------------
\1 Although all the existing prepayment programs cover mandatory fees
in addition to tuition, and some also cover housing and other costs
of college attendance, we refer to them simply as "tuition prepayment
programs" for the sake of brevity.
COLLEGE AFFORDABILITY BECAME
MAJOR CONCERN IN 1980S
---------------------------------------------------------- Chapter 1:1
In the 1980s, a number of factors combined to create the perception
of a college affordability crisis--a perception that persists today.
Chief among these factors was the rapid rise in the cost of college
attendance, especially relative to income growth and general
inflation (see fig. 1.1). From 1980 to 1987, the cost of attendance
at U.S. colleges rose an average of 8.8 percent annually. This
figure was substantially higher than the growth in median family
income during the same period, which increased an average of 5.6
percent per year. Moreover, the increase in college costs was almost
twice as great as the average annual increase in the cost of all
goods and services, as measured by the Consumer Price Index (CPI), at
just 4.7 percent. This pattern was a major reversal from the
previous decade: In the 1970s, college costs rose an average of 6.5
percent per year, while median family income and the CPI went up 7.9
percent and 7.8 percent, respectively. However, the general pattern
of the 1980s has continued into the 1990s, with college cost
increases regularly surpassing general inflation.
Figure 1.1: College Costs
Increased Faster Than Income
and General Inflation in the
1980s
(See figure in printed
edition.)
Source: Arthur M. Hauptman with Jamie P. Merisotis, The College
Tuition Spiral: An Examination of Why Charges Are Increasing (New
York: Macmillan Publishing Co., 1990), p. 4.
Using recent trends in average college cost increases, analysts often
project future prices that can sound astronomical. Last fall, for
example, a magazine devoted to planning for college projected that by
the time a child born in 1994 is ready for college, the average bill
for 4 years of tuition, fees, room and board, books, and
transportation would be about $128,000 at a public school and
$268,000 at a private one. Given such projections for the cost of a
4-year degree in the future, many Americans worry that a college
education might soon be priced beyond their means.
At the same time college costs were climbing faster than family
income, the real value of student financial aid was dropping, further
contributing to the concern over college affordability. Although
total federal aid increased 38 percent in nominal terms from 1980
through 1989, this represented a 1.3-percent decline after adjusting
for inflation. And while state and institutionally awarded aid rose
by 11 percent in real terms, it did not keep pace with college costs,
either. Thus, as one expert put it, "middle-income families, who
might have held out hope that financial aid would be available to
help with college expenses, awakened to diminished prospects for such
assistance at precisely the time that trends in college prices looked
especially ominous."\2
Not only did financial aid fail to keep up with college cost
increases, but a shift from grants to loans meant that students were
borrowing more than in the past, fueling concern about excessive
student debt. In the 1980-81 academic year, grants composed 56
percent of all aid, loans 40 percent, and work-related aid 4 percent.
By 1988-89, however, grants had decreased to 48 percent of all aid,
loans increased to 49 percent, and work-related aid remained about
the same, at 3 percent. In 1976 only 17 percent of tuition costs
were financed with loans, but in 1987 the figure was over 50 percent.
Finally, student debt increased 60 percent between 1980 and 1987.
In light of these various factors--the rising cost of college,
especially compared with increases in family income; declining
financial aid in real terms; and increasing levels of student
debt--it became apparent that fewer families would be able to finance
higher education out of current income while their children were
enrolled in college. Thus, many experts concluded that it was
increasingly important for parents to plan ahead and save for their
children's college educations, so they would have the money in the
future, when they needed it. In the mid- to late 1980s, therefore,
state and federal government officials began looking for ways to help
families to save for college.
--------------------
\2 Janet S. Hansen, "Pay Now. Go Later. College Prepayment and
Savings Plans," The College Board Review, No. 147 (Spring 1988), p.
10.
STATES RESPOND WITH COLLEGE
SAVINGS INITIATIVES
---------------------------------------------------------- Chapter 1:2
Over 30 states have responded to the concern about college
affordability by adopting some type of college saving program. In
1986, Michigan became the first state to pass a law establishing a
tuition prepayment program. Known as the Michigan Education Trust
(MET), the program (1) allowed parents and others to pay for the cost
of tuition and fees at a state college years before a child reached
college age and (2) guaranteed to cover those costs, no matter how
high, when the child eventually enrolled.\3 The idea was a response
to the common worry that, given rapid tuition inflation, even people
who save for college might not have enough money when their children
are ready to enroll.
The program attracted a great deal of attention nationwide, both in
other states and the popular press; in fact, the enactment of MET has
been called "the most widely publicized government action in the
field of higher education finance during the 1980s."\4
Soon, programs similar to MET were under consideration in as many as
40 states. At least 12 other states have passed laws authorizing a
tuition prepayment program, but only 7 had implemented their programs
by 1994: Alabama, Alaska, Florida, Michigan, Ohio, Pennsylvania, and
Wyoming.\5 Most states that considered the idea of a tuition
prepayment program chose instead to adopt a college savings bond
program or another type of savings plan.
--------------------
\3 Because of this guarantee, these programs are sometimes referred
to as "guaranteed tuition programs."
\4 Jeffrey S. Lehman, "The Distribution of Benefits From Prepaid
Tuition Programs: New Empirical Evidence About the Effects of
Program Design on Participant Demographics," Prepaid College Tuition
Plans: Promise and Problems, ed. Michael A. Olivas (New York:
College Entrance Examination Board, 1993), p. 28.
\5 Some states, including Indiana and Tennessee, decided against
implementation; South Dakota and Virginia are still in the planning
stage; Massachusetts implemented its program in February 1995.
Detailed descriptions of the tuition prepayment programs in Alabama,
Alaska, Florida, Michigan, Ohio, Pennsylvania, and Wyoming are
provided in app. I.
TUITION PREPAYMENT PROGRAMS
-------------------------------------------------------- Chapter 1:2.1
Tuition prepayment programs provide a "pay now, learn later" approach
to college financing by allowing people to pay in advance for
educational benefits that a designated beneficiary will use in the
future. The programs charge roughly current prices for tuition and
fees and other prepaid benefits, such as dormitory housing--in some
cases, a premium may be charged; in others, a discount may be
offered. Purchasers may pay for the desired benefits all at once
with a lump-sum payment, or with a series of payments over time.
The revenues from purchasers' payments are pooled into one large fund
and invested with the goal of achieving a rate of return that exceeds
the inflation rate for tuition and fees and other prepaid expenses at
participating institutions, typically in-state public colleges. Each
semester that the beneficiary enrolls in a participating college, the
program pays to the school whatever amount it currently charges for
tuition and fees and any other prepaid benefits. If the prepaid
benefits are not used as intended--for attendance at an in-state
public college--a variety of refund provisions come into play.
COLLEGE SAVINGS BONDS AND
OTHER STATE PROGRAMS
-------------------------------------------------------- Chapter 1:2.2
At the state level, the most common initiative has been to establish
a college saving bond program. Many states have viewed issuing bonds
as less financially risky and easier to administer than tuition
prepayment programs. About 20 states have sold college savings
bonds, though relatively few have done so on a regular basis.
However, these bonds have commonly received a positive response,
selling out very quickly.
State college savings bond programs work as follows. The state
issues general obligation, zero-coupon bonds, marketed as a way for
families to save for future education expenses and targeted at
individual, as opposed to institutional, investors.\6 These bonds,
similar to U.S. savings bonds, are sold at a discount from their
face value and pay no interest until maturity. The bonds typically
are valued at $1,000 to $5,000, with maturities ranging from 5 to 20
years. Generally, the bonds cannot be called in early, meaning the
issuer cannot redeem them prior to maturity. And because the bonds
are state debt instruments, the interest earned is exempt from state
taxes (for residents of the issuing state) and federal taxes (for all
purchasers). Although the bonds are marketed as a way to save for
college, there is no requirement that the funds be spent on college
expenses, and purchasers need not have a designated beneficiary.\7
Furthermore, states use the proceeds from college savings bonds as
they would proceeds from other state bonds, such as to build roads
and bridges.
Finally, some states have implemented other kinds of programs to help
families save for college, different from both tuition prepayment and
college savings bond programs. Kentucky's program, for example,
allows participants to save money in a special college savings
account. People can save as much or as little as they like on behalf
of a designated beneficiary, depending on their individual savings
goals, and deposits may be as low as $25. The program guarantees a
minimum 4-percent rate of return, and the interest earned is exempt
from state--though not federal--income taxes. When withdrawn, the
funds can be spent at virtually any college in the country. However,
a penalty applies if the funds are withdrawn inside of 8 years.
--------------------
\6 Because the bonds are intended as a college savings vehicle, they
are sometimes referred to as baccalaureate bonds.
\7 To encourage purchasers to use these bonds to pay for college,
however, at least one state--Illinois--pays a bonus on redemption if
the funds are spent at an institution of higher education.
FEDERAL PROPOSALS AND ACTION ON
COLLEGE SAVINGS
---------------------------------------------------------- Chapter 1:3
As state officials moved to enact college savings programs in the
late 1980s, the federal government also responded to concerns about
the rising cost of a college education. During the 100th Congress
(1987-88), the Senate Committee on Finance held a hearing on ways to
encourage saving for college, and numerous college-savings proposals
were introduced in the Congress. These proposals, typically
involving preferential tax treatment, included a wide variety of
approaches to encourage college savings:
Some proposals called for the establishment of a national education
savings trust, similar to a state tuition prepayment program.
Individuals would have been able to buy contracts covering a
certain amount of future college expenses at any college in the
country. Participants would have received various tax
advantages, such as (1) a deduction for cash payments to the
program and (2) an income exclusion for the funds paid out by
the program to a college. In addition, the trust itself would
have been designated as a tax-exempt entity, free from federal,
state, and local taxes.
Another proposal would have created federal tuition savings
certificates that could either be redeemed for cash or turned
over to a college as payment for tuition. Colleges that
accepted the certificates and kept tuition increases under a
certain level would have received a bonus based on all the
certificates they redeemed. Taxes on the interest earned from
the certificates might have been deferred and possibly assessed
at the student's tax rate.
Still other proposals would have created special savings accounts
for education featuring various tax advantages, such as a tax
credit for contributions or a tax exclusion on the interest used
to pay for higher education.
The 100th Congress did pass one major college-savings proposal. With
the Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647),
the Congress created a federal income tax advantage for using series
EE savings bonds to pay for certain higher education expenses. For
savings bonds purchased in 1990 or later, taxpayers may deduct from
their gross income the interest earned on bonds used to pay for
tuition and required fees at accredited colleges and universities.
However, there is a phase-out structure for the exclusion, designed
to favor lower- and middle-income families: Taxpayers below a
certain income level may qualify for a full exclusion; those between
the lower and upper income limits for a partial exclusion, decreasing
as their income rises; and those above the upper limit do not qualify
for any exclusion. For 1994, the lower and upper income limits were
$41,200 and $56,200 for single filers, and $61,850 and $91,850 for
joint filers.\8
Passage of the higher education provision for U.S. savings bonds,
however, did not quell lawmakers' concerns about the ability of
American families to pay for college. In subsequent years, Members
of Congress continued to introduce college savings legislation. Over
20 bills addressing tax advantages for college savings were
introduced in the 101st Congress, for example, but none was enacted.
Twice during the 102nd Congress, both houses of the Congress passed
legislation that, among other things, would have allowed penalty-free
withdrawals from individual retirement accounts (IRA) to pay for
higher education expenses, but both bills were vetoed by the
President. Similar proposals were introduced in the 103rd Congress,
but did not pass.
Several more college-savings proposals have been introduced in the
104th Congress. One approach, proposed in two of the bills, would
allow taxpayers to establish special savings accounts, similar to
IRAs. Contributions to these accounts would be made with after-tax
dollars, but distributions used to pay certain higher education
expenses would be deductible from the taxpayer's gross income.
--------------------
\8 For more information on the rules pertaining to the savings bond
income exclusion, see Education Savings Bonds: Eligibility for Tax
Exclusion, Report No. 89-570 EPW, Congressional Research Service,
Library of Congress (Oct. 16, 1989). For information on the extent
to which people have claimed the exclusion thus far, see College
Savings Issues (GAO/HEHS-95-16R, Nov. 4, 1994).
PRIVATE SECTOR COLLEGE SAVINGS
PLANS
---------------------------------------------------------- Chapter 1:4
The private sector also responded to the growing interest in saving
for college. Insurance companies, investment firms, and financial
planners offer a range of services to help parents meet their college
savings goals. One notable private sector initiative is the College
Savings Bank of Princeton, New Jersey, which issues a certificate of
deposit (CD) indexed to annual increases in private college costs and
guaranteed to cover tuition, fees, and room and board in the future,
no matter how high those costs rise. Participants decide how much
and how often to save. The CDs are available in maturities from 1 to
25 years. The minimum initial deposit is $1,000 and subsequent
deposits must be at least $250.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:5
Because of their interest in helping families to save for college
expenses, the Chairman of the Senate Committee on Labor and Human
Resources; the Chairman of the Subcommittee on Education, Arts, and
the Humanities; and Senator Thad Cochran asked us to report on state
tuition prepayment programs. In response, we agreed to (1) describe
how these programs operate and the participation rates they have
achieved, (2) assess participants' income levels and options for
increasing the participation of lower-income families, and (3)
discuss the major issues concerning these programs.
To meet these objectives we
reviewed available literature on these programs, state reports
assessing various college saving programs, and brochures and
other documents produced by, or pertaining to, tuition
prepayment programs;
interviewed key program officials in all seven of the states that
were operating tuition prepayment programs during the time of
our study, financial aid officials in several participating
colleges, federal officials in the Department of Education and
the Internal Revenue Service (IRS), and other experts; and
obtained income data on program participants from state officials,
which we compared with similar data on other state residents
from the Bureau of the Census, including the decennial census
and the Current Population Survey.\9
We conducted our study from June 1993 to May 1995 in accordance with
generally accepted government auditing standards.
--------------------
\9 Further details on our data and analytical methods are presented
in ch. 3.
TUITION PREPAYMENT PROGRAM
OPERATIONS AND PARTICIPATION
LEVELS
============================================================ Chapter 2
Although existing state tuition prepayment programs operate
similarly, they all have unique features that distinguish them from
one another. Until recently, these programs have followed one of two
models for how they package and sell prepaid benefits, but
Massachusetts has now introduced a third model. Analyzing program
participation rates, we found considerable variation between states.
When asked what factors are important for achieving a high level of
participation, program officials emphasized effective advertising and
marketing efforts, a positive public perception, affordability, and
the simplicity and flexibility of the program. We also found that
participation rates are generally higher in states where tuition is
more affordable to the average family.
SIMILARITIES AND DIFFERENCES
BETWEEN STATE TUITION
PREPAYMENT PROGRAMS
---------------------------------------------------------- Chapter 2:1
Existing state tuition prepayment programs share certain basic
similarities in terms of how they operate. A purchaser may be the
beneficiary's parent, grandparent, other relative, or friend, and in
some cases, even businesses and charitable organizations can purchase
tuition benefits on behalf of a designated beneficiary. In most
programs, either the purchaser or the beneficiary must be a resident
of the state to join the program. Also, most states require
beneficiaries to be below a certain age or grade level.
The programs charge roughly current prices for tuition and other
educational benefits at in-state public colleges; however, in some
cases a premium may be charged and in others a discount may be
offered, especially for younger children who are many years away from
enrolling in college. The prices are adjusted annually to reflect
increases in college costs. Purchasers can pay for the desired
benefits either all at once with a lump-sum payment or with a series
of payments over time. To make purchasing the benefits as easy as
possible, some programs offer the option of payroll deductions or
electronic fund transfers. To join the program, would-be purchasers
also generally must pay a nonrefundable application fee. In some
states, the program enrollment period is limited; in others,
enrollment is year-round.
In a sense, the programs operate like pension plans--they invest
money now to meet an estimated future liability. The revenues from
purchasers' payments are pooled in one large fund and invested with
the goal of achieving a higher rate of return than the rate at which
tuition and other prepaid expenses increase. Indeed, beating the
tuition inflation rate is more than just a goal, it is imperative for
programs to succeed. However, in case the fund becomes actuarially
unsound, most states have built in an escape clause that would allow
them to end the program and issue refunds to the participants.
Each semester that the beneficiary enrolls in a participating
college, the program pays to the school whatever amount it currently
charges for tuition and fees and any other prepaid benefits, such as
housing expenses. Beneficiaries who are not state residents when
they enroll in a participating college may be required to make up the
difference between in-state and out-of-state tuition rates.
Typically, the benefits can be used for several years after the
beneficiary reaches college age.
Various refund provisions apply if the beneficiary cannot use the
benefits due to death or disability; chooses not to go to college at
all; or decides to attend a nonparticipating college, such as a
private college or an out-of-state public college. (The programs do
not guarantee that the beneficiary will be accepted for enrollment at
one of the participating colleges.) Under certain circumstances, the
programs allow a new beneficiary to be named in place of the original
one; however, prepaid benefits may not be sold or traded.
Despite the overall similarities between state tuition prepayment
programs, each state's program is unique in its details, with
different costs, rules, and other program features. Table 2.1
presents an overview of the seven programs we studied.
Table 2.1
State-by-State Comparison of Tuition
Prepayment Programs
Pennsylv
Alabama Alaska Florida Michigan Ohio ania Wyoming
-------- -------- -------- -------- -------- -------- -------- ----------
When did Summer Spring Fall Fall Winter Fall Summer
the 1989 1991 1988 1988 1989 1993 1987
program
start?
What Contract Tuition Contract Contract Tuition Tuition Contract
does a credits credits credits
purchase
r buy?
What is In 1993: As of As of As of In 1994: As of As of fall
the cost $7,961 fall fall fall $15,000 fall 1993:
of a for an 1993: 1993: 1990: 1993: $28,182
lump- 8th $7,920 $5,879 $15,496 $12,057 for a 4th
sum grader, for an for a for grader,
payment $4,892 11th 12th state $14,462
for 4 for an grader, grader, system for a
years of infant $5,639 $8,380 schools, newborn
tuition for a for a $21,918
and fees newborn newborn for
at a state-
state related
college? schools
What None None Housing None None None Room and
addition board
al types
of
benefits
can a
purchase
r buy?
How many 15 4- 1 4- 9 4- 15 4- 13 4- 18 4- 1 4-year
institut year year year year year year institutio
ions institut institut institut institut institut institut n and 7
particip ions and ion ions and ions and ions and ions and community
ate in 35 (3 28 29 23 14 colleges
the communit campuses communit communit communit communit
program? y ) and 1 y y y y
colleges communit colleges colleges colleges colleges
\a y
college
Is there Yes No Yes Yes Yes Yes No
a
residenc
y
requirem
ent for
either
the
purchase
r or the
benefici
ary?
Can a No Yes Yes No Varies No Varies by
benefici by school
ary move school
to
another
state
and
still
qualify
for
resident
rate
when
using
benefits
at time
of
enrollme
nt?
When can May 1- Year- Mid- Before Year- Year- Year-
people 31 round October contract round round round
join -mid- sales
program? January were
halted
in 1991,
enrollme
nt took
place in
the fall
Does the Yes \b Yes Yes \b \b No
program
offer
monthly
payment
contract
s?
What is Contract 6 Contract Contract 1 credit 1 Contract
the for 4 tuition for 2 for 1 tuition for 1 year
minimum years of credits years of year of unit (1/ of tuition
amount tuition initiall tuition tuition 20 of a and fees
of and fees y and at a and fees tuition
benefits subseque communit credit)
that can nt y
be purchase college
purchase s of 1
d? credit
What is 4 years \b 4 years 4 years 400 \b 4 years
the of credits
maximum tuition
amount and
of fees; 5
benefits years of
per dormitor
benefici y space
ary?
Can a
purchase
r or
benefici
ary get
a refund
with
interest
in case
of
--death Yes Yes Yes Yes Yes Yes Yes
or
disabili
ty of
the
benefici
ary?
-- No No No Yes No No Yes
voluntar
y
withdraw
al?
--a No No No Yes No No Yes
decision
not to
attend
college?
Can the Yes Yes Yes Yes Yes Yes Yes
value of
benefits
be used
toward
cost of
attendan
ce at a
nonparti
cipating
institut
ion?
Can Yes Yes Yes Yes Yes Yes Yes
benefits
be
transfer
red to
someone
else?
How long 10 years 15 years 10 years 9 years No 15 years 6 years
after (extensi (extensi (extensi stipulat (extensi
anticipa ons ons ons ion on ons
ted allowed) allowed) allowed) when allowed)
college benefits
enrollme can be
nt date used
can
benefits
be used?
How much $75 $40 $42 $25, $50 $65 None
is the plus a
applicat $60
ion fee? processi
ng fee
Are
there
any
addition
al fees
for
-- Yes \b Yes - Yes - \b \b \b
failing $10 $10
to make
payments
on time?
-- Yes Yes - Yes Yes - No Yes - No
voluntar $50 $200 $10
y
withdraw
al from
the
program?
-- Yes No Yes Yes Yes - No No
involunt $25
ary
terminat
ion due
to
failure
to use
benefits
,
default,
or
fraud?
-- Yes Yes - Yes -$5 Yes - Yes - Yes - No
benefici $20 $25 $25 $10
ary
substitu
tion?
-- Yes \b \b \b \b Yes - No
transfer $10
of
contract
ownershi
p?
Are No \b \b Yes No No \b
benefits
taxed by
the
state?
Is the No No Yes No Yes No No
program
backed
by the
full
faith
and
credit
of the
state?
Will the Yes Refund Yes, for Refund Refund Yes Yes
program benefici
honor aries
benefits within 5
if the years of
program college
is enrollme
terminat nt.
ed? Others
will
receive
a refund
with
interest
.
--------------------------------------------------------------------------------
\a Although some states also have "junior colleges," "technical
colleges," or "senior colleges," we use the term community colleges
to represent all public 2-year institutions.
\b Not applicable.
TWO MAIN TYPES OF PREPAYMENT
PROGRAMS
-------------------------------------------------------- Chapter 2:1.1
Until recently, state tuition prepayment plans have followed one of
two basic models in terms of how they package and sell their
education benefits. Michigan's tuition prepayment program served as
a general model for those adopted later in Wyoming, Florida, and
Alabama. Under these states' programs, purchasers sign a contract to
buy a predetermined amount and type of tuition benefits. For
example, Florida's program offers prepaid tuition contracts for 2
years at a community college, 2 years at a community college plus 2
years at a state university, or 4 years at a state university.\10
Typically, if the purchaser fails to pay for the benefits as agreed,
program officials will cancel the contract and issue a refund.
Furthermore, in prepayment programs such as these, the price of the
benefit packages varies by the age of the beneficiary, with prices
highest for those children closest to college age and lowest for
newborns/infants.\11 For example, during the 1993-94 enrollment
period in Florida, a lump-sum payment for a contract guaranteeing 4
years at a state university was about $5,900 for a child in eleventh
grade and about $5,600 for a newborn.\12
Ohio took a slightly different approach with its tuition prepayment
program, which became a general model for those established later in
Alaska and Pennsylvania. In these states, purchasers open a prepaid
tuition account for a designated beneficiary by making an initial
minimum purchase; thereafter, they may buy whatever amount of
benefits they desire--typically, up to a cumulative maximum of 4
years--at any time. These programs are sometimes referred to as
prepaid tuition credit programs, because they sell tuition benefits
by the credit hour, or in even smaller units. Thus far, none of
these account-based prepayment programs has offered housing benefits.
The prices of tuition benefits for these programs do not vary by the
beneficiary's age; rather, all purchasers pay the same price for the
same type of benefit.
--------------------
\10 Purchasers of a 4-year state university contract in Florida can
also prepay the cost of up to 5 years of housing benefits,
guaranteeing the beneficiary a space in a university dormitory.
\11 The programs we reviewed used either "newborn" or "infant" to
describe the youngest age category.
\12 In Alabama's program the difference between the highest and
lowest prices is much greater, reflecting a significant discount for
younger children. In 1993, the lump-sum payment for a 4-year
contract was $7,961 for an eighth grader and $4,892 for an infant.
MASSACHUSETTS PROGRAM
REPRESENTS NEW PREPAYMENT
MODEL
-------------------------------------------------------- Chapter 2:1.2
In February 1995, Massachusetts introduced a tuition prepayment plan
different from all others. The program sells "tuition certificates"
redeemable toward the cost of tuition and fees at any public or
private college in the state that agrees to participate in the
program; 67 institutions have signed up so far. The certificates are
guaranteed to hold their value until redeemed by the beneficiary.
For example, if a $1,200 certificate is equal to 20 percent of
tuition costs at a given college at the time of purchase, the
certificate will cover that same percentage of costs when the
beneficiary enrolls at that college in the future. Actually, the
program will pay colleges an amount equal to the face value of the
certificate plus interest at the rate of 2 percent above the CPI,
compounded annually. Thus, the colleges accept the risk that their
costs will rise more than the value of the certificates. Because the
certificates are based on state bonds, they are exempt from state
taxes, and program officials expect they will also be exempt from
federal taxes. The minimum purchase is $300 per beneficiary per
maturity year.
PROGRAMS HAVE ACHIEVED VARYING
PARTICIPATION RATES
---------------------------------------------------------- Chapter 2:2
One measure of the success of state tuition prepayment programs is
their overall participation level--the total number of contracts
purchased or tuition accounts opened. Naturally, a goal of any
program like this is to get as many families saving for college as
possible. We found that the number of participants in existing state
tuition prepayment programs varies considerably, largely due to
differences in the state's population and the number of years the
program has been in operation. To account for such differences, we
calculated the average annual participation rate for each program.
We divided the average number of new participants per year by the
number of children in the state most likely to become beneficiaries
in these programs. We defined this target group as the number of
children below the age limit for joining the program and not living
in poverty.\13 Our results are shown in table 2.2.
Table 2.2
Participation Statistics for State
Tuition Prepayment Programs
Number Average Average
Total of number annual
number enroll of participat
of ment particip Size of ion rate
particip period ants per target (percent)\
State ants s year group a
-------- -------- ------ -------- -------- ----------
Alabama 33,379 4 8,345 660,922 1.26
Alaska\b 9,053 3 3,018 145,963 2.07
Florida 256,339 7 36,620 2,330,31 1.57
7
Michigan 54,717 3 18,239 2,127,62 0.86
5
Ohio 31,989 5 6,398 2,169,16 0.29
2
Pennsylv 7,713 1 7,713 1,965,04 0.39
ania 9
Wyoming 693 7 99 70,414 0.14
----------------------------------------------------------
\a Typically, the first year of operation yields a much higher number
of participants than the following years. Therefore, over time these
rates will likely decrease.
\b Figures for Alaska represent number of contracts, not number of
beneficiaries; a given beneficiary may have several contracts.
Sources: Tuition prepayment program officials and U.S. Bureau of
the Census.
While none of the seven programs has achieved an average annual
participation rate that seems very high, quite a bit of variation
exists between states. For example, during its first 7 enrollment
periods, Florida's program sold an average of about 37,000 tuition
contracts per year, equivalent to 1.57 percent of nonpoor children in
the eligible age range. In contrast, Wyoming's program has sold an
average of fewer than 100 contracts per year, which is 0.14 percent
of its target group. Nonetheless, if sustained over several years,
even seemingly small average annual participation rates can
eventually result in a large number of program participants, as is
the case in Florida.
--------------------
\13 For states that do not have an official age limit, we subtracted
the number of years beneficiaries must wait to use their benefits
from 18, the age at which students typically enroll in college. The
age limits we used were, for Alabama, 14; Alaska, 16; Florida, 17;
Michigan, 18; Ohio, 16; Pennsylvania, 14; and Wyoming, 10. (In
states with prepaid credit programs, however, credits can still be
purchased for beneficiaries past the age limits we used.) We excluded
poor children because their families are unlikely to join these
programs (see ch. 3).
EXTENT OF PARTICIPATION ALSO
VARIES
-------------------------------------------------------- Chapter 2:2.1
The average annual participation rate is an imperfect indicator of
program participation, because it does not reflect the varying extent
to which people are participating. It counts each participant
equally, whether he or she has paid for 4 years of tuition benefits
or just a few tuition credits; it even includes individuals who
joined these programs but later withdrew. Therefore, to give a more
complete picture of program participation, we also obtained data on
the amount and type of tuition benefits purchased for beneficiaries
in each program, and available information on program cancellation
rates.
Alabama features only one benefit plan--a contract covering 4 years
of tuition and fees at any public college or university in the
state. Officials report a 6-percent cancellation rate.
In Alaska, as of June 1993, roughly 54 percent of participants had
purchased 1 year's worth of tuition credits or less, about 30
percent had bought 1 to 2 years' worth, about 11 percent had
bought 2 to 4 years' worth, and about 5 percent had bought more
than 4 years' worth.
In Florida, about 74 percent of participants have purchased a
contract covering 4 years at a state university, about 21
percent have bought contracts for 2 years at community college
plus 2 years at a state university, and about 5 percent have
bought contracts for 2 years at a community college. Of those
who have chosen a 4-year state university contract, about 39
percent have also purchased a dormitory contract covering 1 to 5
years of housing costs. Of the roughly 220,000 tuition and
dormitory contracts purchased in the first 5 enrollment periods,
about 15 percent had been cancelled by September 1993.
In Michigan, about 96 percent of participants bought the full
benefits contract, less than 1 percent bought a limited benefits
contract, and about 4 percent bought a community college
contract.\14 Very few MET contracts have been cancelled.
In Ohio, as of January 1995, 72 percent of participants had paid
for 1 year's worth of tuition credits or less, 13 percent had
bought 1 to 2 years' worth, 6 percent had bought 2 to 4 years'
worth, and 9 percent had bought 4 years' worth.
In Pennsylvania, as of November 1994, about two-thirds of
participants had purchased tuition benefits (credits or units)
for state related universities, almost one-third had bought
benefits for universities in the state system of higher
education, and only about 2 percent had bought benefits for
community colleges. The average amount of money spent by each
participant was $2,700.
In Wyoming, 91 percent of participants have purchased contracts
covering 4 years at the University of Wyoming, 4 percent have
contracts for 1 to 3 years at the University, 4 percent have
contracts for 2 years at a community college plus 2 years at the
University, and 1 percent have 2-year community college
contracts. Of all contracts purchased, 94 percent cover room
and board in addition to tuition and fees. To date, only three
contracts have been canceled.
--------------------
\14 The full benefits contract covers tuition and fees at any
Michigan public university or community college. The limited
benefits contract covers tuition and fees only at Michigan public
colleges whose tuition costs do not exceed 105 percent of the
weighted average tuition cost of Michigan's 4-year institutions. The
community college contract covers tuition and fees at any of
Michigan's community colleges.
SEVERAL FACTORS CONSIDERED
IMPORTANT FOR MAXIMIZING NUMBER
OF PARTICIPANTS
---------------------------------------------------------- Chapter 2:3
Clearly, program participation rates are not solely dependent on the
size of a state's population and the number of years its program has
been operating. When asked what factors were important for
maximizing the number of participants, program directors emphasized
advertising and marketing, the public's perception of the program,
program simplicity and flexibility, and affordability.
DEVELOPING EFFECTIVE
ADVERTISING AND MARKETING
STRATEGIES
-------------------------------------------------------- Chapter 2:3.1
Several officials mentioned the significance of effective advertising
campaigns or other marketing strategies; in fact, some ranked
advertising or marketing as the single most important factor for
maximizing program participation. Programs have adopted a wide range
of advertising and marketing strategies to reach out to potential
participants. Following are some examples of these efforts.
Michigan's program mailed packets of information to elementary and
secondary schools, advertised on place mats used at a major
fast-food chain, and distributed flyers in the largest grocery
store chain in the state. Michigan also produced a short,
informational videotape about the program that could be borrowed
free from video rental stores and public libraries throughout
the state.
Florida's program, which has an annual advertising budget of
$500,000, pays for numerous television and radio commercials--in
both English and Spanish--during the 3-month enrollment period.
Similar to strategies used in Michigan, the program mails
packets of brochures to every elementary and secondary school in
the state, and it also distributed a videotape to video rental
stores throughout the state. "Florida has averaged over 40,000
prepaid contracts each year," wrote the program's Director,
"because it has approached consumers rather than expecting them
to seek out the program."\15
Alabama's program has never paid for commercial advertising,
relying instead on public service announcements; when done
correctly, the Director said, this method can be quite effective
for reaching potential purchasers.
Alaska's program Director also said paid advertising may not be
necessary to reach potential customers. Alaska's primary
marketing strategy is to enclose information about the
prepayment program in the annual mailing that goes to all state
citizens concerning their Permanent Fund dividend.\16
Pennsylvania's program also uses the mailing services of another
state agency: a brochure on the tuition prepayment program is
included in every license renewal notice sent out by the Bureau
of Motor Vehicles--over 20,000 per day. Like Michigan and
Florida, Pennsylvania also produced a videotape on its program,
which officials distributed to about 5,000 schools in the state.
Ohio's program has done some advertising on television and radio,
but found newspaper ads to be the most effective form of paid
advertising. The program also does extensive marketing in
schools, and officials work at trade shows and youth fairs to
promote the program and to give away items like refrigerator
magnets and jar openers with the program's logo printed on them.
Ohio also does grassroots outreach, such as having program
participants volunteer to speak at meetings of various community
and civic groups.
Officials had differing opinions about the challenge involved in
getting people to join a tuition prepayment program. One said it is
difficult to get people to save money for anything, let alone their
children's college educations, which could be many years away. In
contrast, however, one official said that prepaid tuition benefits
are naturally appealing, and that once people are aware of the
program, it practically sells itself.
--------------------
\15 William Montjoy, "State Prepaid Tuition Plans: Designing a
Successful Program," Prepaid College Tuition Plans: Promise and
Problems, ed. Michael A. Olivas (New York: College Entrance
Examination Board, 1993), p. 47.
\16 The Permanent Fund is made up of revenues from oil companies
doing business in the state. Every year, a portion of the fund's
earnings is distributed, as a dividend, to all state residents.
Everyone receives the same amount, regardless of income, age, or
other factors.
ACHIEVING AND MAINTAINING
POSITIVE PUBLIC PERCEPTION
-------------------------------------------------------- Chapter 2:3.2
Another factor considered important for achieving a high
participation rate is developing a positive public perception of the
program. Several officials described the need to build and maintain
the public's confidence in the program as a safe, reliable way to
provide for children's college educations.
One way to develop a positive image, some officials said, is through
the involvement of a well-known, high-profile supporter, someone who
can attract the public's attention and stir up interest in the
program. In some states this role has been played by the state
treasurer. Another key is getting positive coverage by the news
media; for example, several officials mentioned the importance of
favorable newspaper stories and editorials about the program.
The fact that these programs are affiliated with the state government
or the state university, a few officials said, may also help some
participants to have confidence in the program. That is, people
could be more trusting and feel more comfortable dealing with public
officials than with private investment advisors. However, being a
state-sponsored program can cut both ways, one official said, because
some people strongly distrust government and would not voluntarily
give their money to the state for any purpose. Furthermore, although
these programs are connected with the state, some officials stressed
the importance of trying to remain nonpartisan in a political
environment. "If the public's impression is that the program has
become politicized," wrote Florida's Director, "confidence will be
lost and sales will plummet."\17
The connection between public perception and sales levels is clear to
Ohio's program Director. She said public confidence in the state's
program was shaken somewhat last year when state newspapers widely
reported that the Governor had questioned whether the program was a
good deal for participants. As the Governor's office, the
legislature, and program officials decided what to do about the
program, the number of new participants dropped to less than 2,000 in
1994, after averaging over 5,300 in the preceding 3 years. The
issues in question have been resolved, according to the Director--the
program is now a better deal than ever, she said, with lower prices
and backed by the full faith and credit of the state--but now
officials must rebuild a positive public perception of the program to
increase sales to their previous level.
--------------------
\17 Montjoy, "State Prepaid Tuition Plans," p. 48.
CREATING A SIMPLE, FLEXIBLE
PROGRAM
-------------------------------------------------------- Chapter 2:3.3
Two additional factors that officials described as important for
achieving a high participation level were program simplicity and
flexibility. In terms of simplicity, one official explained that
typical participants in these programs do not have experience with
complex, sophisticated investment vehicles; they are looking for a
program that is easy to understand. Some officials described coupon
books as a simple way for purchasers to make payments. Here is how
Florida's program Director addressed this general issue: "In
marketing a prepaid program, every effort should be made to keep it
simple. One of the primary elements of success is providing a plan
that the public can easily understand and use. Facilitating
applications, without imposing numerous rules and guidelines, is
critical to contract sales volume."\18
In addition to being simple, some officials said, tuition prepayment
programs must also be flexible. They need to offer purchasers and
beneficiaries a range of choices, such as different types of benefit
plans and payment options. These programs should also not prohibit
early withdrawals, according to one official; purchasers should be
able to get back at least their principal if needed. Flexible
features are often emphasized in program literature. For example,
Pennsylvania's program brochure describes how purchasers can buy
credits at any time, in any amount desired, and that students can use
their benefits toward the cost of any accredited college in the
country. Florida's brochure mentions the ability to convert from one
benefit plan to another, and that students can use their benefits
while attending college part time over more than 4 years.
The notion that program flexibility is associated with participation
levels is supported by anecdotal evidence from Florida. In the
spring of 1993 the program changed its rules to allow beneficiaries
to use the full value of their benefits toward attendance at
out-of-state colleges; prior to then, they could receive the
principal but no interest. While the number of tuition contracts
sold the previous 3 years averaged about 30,000, during the 1993-94
enrollment period, sales jumped to about 44,000.
--------------------
\18 Montjoy, "State Prepaid Tuition Plans," p. 47.
MAKING PROGRAM AFFORDABLE
-------------------------------------------------------- Chapter 2:3.4
A few officials stressed program affordability as another key to
achieving a high level of participation. Alabama and Michigan tried
to make their programs more affordable by offering substantial
discounts on contracts for younger children. Ohio and Pennsylvania
sell tuition benefits in small units, rather than multiyear contracts
that might seem prohibitively expensive, given the relatively high
cost of tuition in those states. In addition to making the prepaid
benefits affordable, another official mentioned the importance of
keeping program fees at a reasonable level, so as not to impose a
financial burden on participants. Initial fees for the programs we
reviewed ranged from none in Wyoming to $75 in Alabama.
Affordability, of course, is also a function of people's incomes. In
deciding whether to participate in these programs, one official
explained, potential purchasers ask themselves if the payments will
fit into their monthly budgets. When people find it difficult to
make ends meet or are worried about their job security, they are less
likely to make a significant financial commitment to these programs,
and those who are already participating may decide to cancel their
contracts or stop purchasing credits. For example, a couple of
officials reported that the recession in the early 1990s hurt program
sales.
PARTICIPATION LEVELS LINKED TO
COLLEGE AFFORDABILITY
---------------------------------------------------------- Chapter 2:4
In general, program participation is higher in states where tuition
is more affordable. To measure affordability for each state, we
first obtained Department of Education data on the average cost of 1
year of tuition and fees at 4-year public colleges during each year
the program has been in operation. Second, we used data from the
Census Bureau's Current Population Survey (CPS) for the same years to
determine the annual median family income for all families with
children under age 18. Finally, we divided the tuition cost by the
median income, and averaged the percentages over the years the
program has been operating. We then compared each program's
affordability measure with its average annual participation rate,
described above. As table 2.3 shows, with the exception of Wyoming
(which has had the most affordable tuition rates and the lowest
participation rate), as tuition accounts for a smaller percentage of
median family income, participation generally rises. This analysis
suggests that tuition prepayment programs will be more successful in
states where tuition is relatively more affordable to the average
family.
Table 2.3
Participation Generally Higher in States
Where Tuition Is More Affordable
(Numbers in percent)
Percentage of family
income needed to cover Average annual
State tuition and fees\a participation rate
---------- ---------------------- ----------------------
Wyoming 3.19 0.14
Alaska 3.84 2.07
Florida 4.37 1.57
Alabama 5.28 1.26
Michigan 6.27 0.86
Ohio 7.30 0.29
Pennsylvan 9.57 0.39
ia
----------------------------------------------------------
\a Average percentage of median family income needed to cover the
cost of 1 year's tuition and fees for a state resident at 4-year
public colleges and universities during the years the program has
been selling prepaid benefits.
INCOME DISTRIBUTION OF
PARTICIPANTS AND OPTIONS FOR
INCREASING LOWER-INCOME
PARTICIPATION
============================================================ Chapter 3
By comparing the income distribution of program participants to that
of other families living in tuition prepayment states, we found that
participants come disproportionately from middle- and upper-income
families. However, officials saw drawbacks to the use of
sliding-scale fees and tax credits, and were not optimistic about the
chances of significantly increasing lower-income participation in
their programs. Most of these states have explored ways to give
prepaid tuition scholarships to needy students, although these
efforts generally have not been very successful. Despite efforts to
make prepaid benefits affordable to all families, a significant
increase in lower-income participation is unlikely, given that such
families lack discretionary income; unable to save substantially for
college, such families will have to rely more on various financial
aid programs.
MOST PARTICIPANTS COME FROM
MIDDLE- AND UPPER-INCOME
FAMILIES
---------------------------------------------------------- Chapter 3:1
Participants in tuition prepayment programs mainly come from middle-
and upper-income families. For example, in each of the three states
with the best available income data on participants--Florida,
Alabama, and Ohio--most families with children under 18 had annual
incomes of under $30,000 in 1992, while most purchasers reported
incomes of $50,000 and above. For the other four states, which did
not have direct measures of participant income, our analysis
generally indicated that a disproportionate percentage of program
participants live in zip codes with relatively high median incomes.
INCOME ANALYSIS AND RESULTS
FOR FLORIDA, ALABAMA, AND
OHIO
-------------------------------------------------------- Chapter 3:1.1
Officials in Florida, Alabama, and Ohio were able to provide us with
self-reported income data on program participants. For both Florida
and Alabama, the program application contains an optional question
for purchasers to indicate their family income level in one of
several categories, such as less than $20,000, $20,000-$29,999,
$30,000-$39,999, $40,000-$49,999, and $50,000 or more. Both states
provided us with these data for several enrollment years. We
compared the income distribution of program participants in these two
states with that of all state families with children under 18, using
CPS data.
For Florida, we limited our analysis to include only purchasers who
were parents of beneficiaries under age 18 at the time of enrollment.
This provided the best possible comparison with the families
represented by the CPS data. The response rate to the optional
income question among this group of purchasers was about 63 percent.
However, after comparing the payment plans and contract types chosen
by respondents and nonrespondents, we have no reason to believe their
income distributions differ substantively.
For Alabama, our analysis of program application data included all
purchasers with beneficiaries under 18, regardless of their
relationship to the beneficiary. Although program officials did not
provide specific numbers, they said the vast majority of purchasers
are parents of the designated beneficiaries. The response rate to
the optional income question was about 72 percent. Alabama also
provided us with state income tax data on over 25,000 program
purchasers, representing 93 percent of all active purchasers as of
fall 1994.\19 We compared purchasers' total income from their 1992 or
1993 state tax return (whichever was the most recent available) with
the same CPS data used in the preceding analysis.
Ohio's tuition prepayment program does not routinely collect income
data on its participants. The income data we present come from a
1992 market study conducted for the program by a private consulting
firm.\20 The study used telephone interviews of 200 purchasers and
400 nonparticipants in the state with children or grandchildren aged
14 and under. We adjusted the percentages reported in the study to
reflect only respondents who answered the income question, which
included about 85 percent of each group.
In Florida, most program participants come from middle- and
upper-income families. Over one-half of the 1992-93 purchasers in
our analysis reported incomes of $50,000 or more, compared with about
one-quarter of all Florida families. In addition, only 5 percent of
the participating parents had incomes of less than $20,000, compared
with 36 percent of all families in the state. (See fig. 3.1.) The
data for other years we examined yielded very similar results.
Figure 3.1: Income Levels of
Families Participating in
Florida's Program, Compared
With All Families in the State
(See figure in printed
edition.)
Note: Percentages may not add to 100 because of rounding. Sampling
errors for CPS estimates do not exceed plus or minus 3 percentage
points.
Sources: Florida program officials and Bureau of the Census' 1993
Current Population Survey.
The results for Alabama were very similar to Florida's. About 60
percent of all 1992 purchasers in our analysis reported incomes of
$50,000 or more, compared with about 20 percent of all families in
the state. At the lower end of the scale, only 2 percent of the
purchasers reported incomes of less than $20,000, compared with about
35 percent of all Alabama families. (See fig. 3.2.) In other years,
the results were comparable. The Alabama tax return data produced
results similar to the program application data. For example, only 8
percent of purchasers had 1992 or 1993 incomes of less than $20,000
and 66 percent had incomes of $50,000 and above. Furthermore, the
median income for purchasers was about $61,000, compared with about
$27,400 for all families in the state.
Figure 3.2: Income Levels of
Families Participating in
Alabama's Program, Compared
With All Families in the State
(See figure in printed
edition.)
Note: Sampling errors for CPS estimates do not exceed plus or minus
6 percentage points.
Sources: Alabama program officials and Bureau of the Census' 1993
Current Population Survey.
The income distributions of participants and other families in Ohio
are similar to those in Alabama and Florida. About 60 percent of
purchasers reported incomes of $51,000 or above in 1992, compared
with less than 20 percent of nonparticipating families. In addition,
only 2 percent of the purchasers had incomes of less than $21,000,
compared with about 30 percent of nonparticipants. (See fig. 3.3.)
Figure 3.3: Income Levels of
Participants in Ohio's Program,
Compared With Nonparticipants
in the State
(See figure in printed
edition.)
Note: Percentages based on responses by approximately 170
participants and 328 nonparticipants with a child or grandchild aged
14 or under.
Source: Ohio Tuition Trust Authority Market Survey.
--------------------
\19 The tax data provided by the Alabama Department of Revenue did
not include individuals' names, social security numbers, or any other
personal identifiers. Active purchasers includes all those who are
either paid in full or continuing to make payments on their
contracts.
\20 OTTA Market Survey Report, Clark Jones Inc. (Columbus, Ohio:
Aug. 1992).
INCOME ANALYSIS AND RESULTS
FOR REMAINING STATES
-------------------------------------------------------- Chapter 3:1.2
The four remaining states--Alaska, Michigan, Pennsylvania, and
Wyoming--do not collect income data on their purchasers, but they did
have a record of each purchaser's zip code, which we used as a rough
proxy for income. First, we used 1990 Decennial Census data to
determine the median household income and the total number of
residents under age 18 for every zip code in each state. Next, we
assigned the median household income of each zip code to each child
living in that zip code. Then we divided the number of children in
each state into quartiles on the basis of their assigned income.
Finally, we determined the percentage of program purchasers living in
each of the income quartiles. If there were no relationship between
income and program participation, we would expect to find about 25
percent of purchasers living in each quartile. Our findings are
shown in table 3.1.
Table 3.1
Income Distribution of Purchasers in
Alaska, Michigan, Pennsylvania, and
Wyoming
Percentage Percentage Percentage
Incom of of of Percentage
e purchasers purchasers purchasers of
quart Income in Income in Income in Income purchasers
ile range quartile range quartile range quartile range in quartile
----- -------- ---------- ------ ---------- ------ ---------- ------ ------------
Lowes $33,801 20 $24,36 7 $22,80 13 $22,95 29
t and 4 and 2 and 5 and
under under under under
Secon $33,802 26 $24,36 16 $22,80 22 $22,95 27
d - 5 - 3 - 6 -
lowe $42,868 $30,65 $28,33 $26,25
st 8 3 0
Secon $42,869 27 $30,65 23 $28,33 27 $26,25 25
d - 9 - 4 - 1 -
high $47,472 $38,38 $35,23 $33,42
est 2 0 7
Highe More 28 More 54 More 38 More 19
st than than than than
$47,472 $38,28 $35,23 $33,42
2 0 7
=========================================================================================
Total 100 100 100 100
\b
-----------------------------------------------------------------------------------------
\a Figures represent number of contracts, not number of
beneficiaries; a given beneficiary may have several contracts.
\b Totals may not add to 100 because of rounding.
In Alaska's program, purchasers were almost evenly distributed among
the four income groups, with a slightly lower percentage living in
the lowest-income quartile. About 28 percent of purchasers lived in
the zip codes that made up the highest-income quartile, with median
incomes over $47,472, and about 20 percent lived in the zip codes
composing the lowest-income quartile, with median incomes of $33,801
or less.
In Michigan, the distribution of purchasers was more skewed toward
the higher-income quartiles than in the other three states. Over
half of the purchasers were from the zip codes included in the
highest-income quartile, with median incomes of $38,282 and above.
In contrast, purchasers residing in the zip codes composing the
lowest-income quartile, with median incomes of less than $24,364,
represented only about 7 percent of all purchasers.\21
In Pennsylvania, people from the higher-income zip codes accounted
for a somewhat disproportionate share of program participants. About
38 percent of purchasers were living in the zip codes that
constituted the highest-income quartile, with median incomes over
$35,230. In contrast, about 13 percent of purchasers were living in
the zip codes composing the lowest-income quartile, with median
incomes of $22,802 or less.
In Wyoming, the distribution of purchasers was reversed from what we
found in the other three states. Although purchasers were almost
evenly distributed among the four income groups, slightly more lived
in the lower-income quartiles than in the higher-income quartiles.
About 19 percent of the purchasers lived in the zip codes composing
the highest-income quartile, with median incomes of $33,427 and
above, while about 29 percent lived in the zip codes that made up the
lowest-income quartile, with median incomes of $22,955 or less. We
are not sure what factors might account for this finding.
--------------------
\21 Following a similar methodology, another researcher previously
found similar results for Michigan participants, showing 50 percent
of the beneficiaries residing in the richest quintile of state zip
codes, compared with only 4 percent living in the poorest quintile.
See Jeffrey S. Lehman, "Social Responsibility, Actuarial
Assumptions, and Wealth Redistribution: Lessons About Public Policy
From a Prepaid Tuition Program," Michigan Law Review, Vol. 88 (Apr.
1990), pp. 1035-1141 (see especially app. 1, pp. 1134-1141).
VARIABLE FEES, TAX CREDITS
CONSIDERED POOR OPTIONS FOR
INCREASING LOWER-INCOME
PARTICIPATION
---------------------------------------------------------- Chapter 3:2
Program directors believed that using sliding-scale fees and offering
tax credits would have drawbacks as options for increasing
participation among lower-income families; specifically, they
expressed concerns about administrative feasibility and
effectiveness. Although other options could be developed, we asked
officials for their opinions on these two options because they were
mentioned in the literature.
SLIDING-SCALE FEES
-------------------------------------------------------- Chapter 3:2.1
Officials did not respond favorably to the idea of implementing a
sliding-scale fee system, in which upper-income purchasers would pay
more for tuition benefits and lower-income purchasers would pay less.
Their primary objection was that such a system would pose substantial
administrative problems. It would require them to verify purchasers'
incomes, which would be very labor-intensive and especially difficult
with limited staff resources. Officials might also have to set up an
appeals process, one director said, which would make the programs
seem too bureaucratic. Another official said programs might need to
obtain special legal authority to verify purchasers' incomes by
checking state tax records, because of confidentiality concerns.
Finally, a few officials also said a sliding-scale fee system would
make it more difficult to make sound actuarial assumptions, because
of less certainty about expected revenues.
Besides voicing concerns about administrative feasibility, some
officials offered additional reasons why they thought a sliding-scale
fee structure might not succeed. For example, two program directors
said the concept of charging different prices on the basis of income
would be unappealing to many program participants. Applying an
income test, one said, would make tuition prepayment seem more like a
"social program" and less like an individual savings program. People
with above-average incomes would feel penalized, as though they were
being required to subsidize others, when all they wanted to do was to
help their own children. The program is more appealing, the other
director said, when all participants are treated the same.
Another program director had concerns about the fairness of a
sliding-scale fee structure. Would it be fair, he asked, to charge
variable prices for people who prepay the cost of tuition, based on
their incomes, while people who wait to pay for tuition when their
children enter college would all face the same rate, regardless of
their income? The same official also pointed out that family income
can change over time, sometimes dramatically, which could result in
some families having prepurchased tuition at a rate that does not
reflect their income level when their child is ready for college.
TAX CREDITS
-------------------------------------------------------- Chapter 3:2.2
Compared with their reactions to the idea of sliding-scale fees,
officials were somewhat more favorable toward the concept of offering
a state or federal tax credit to lower-income purchasers. A few
directors thought the idea might succeed in increasing the
participation rate among lower-income families. In addition, one
official pointed out that because his state does not have an income
tax, the tax credit would have to be offered by the federal
government; presumably, he said, this would mean fewer administrative
headaches for state program officials.\22
Some officials, however, doubted whether a tax credit would
appreciably increase the participation of lower-income families. The
problem with a tax credit, two officials said, is that it would not
benefit lower-income families until they filed their tax returns; in
other words, such families would still find it financially difficult
to join the program and make payments in the initial months. Two
officials also thought the idea might not succeed because potential
purchasers might not fully understand how a tax credit works.
Another official said that although the concept has some appeal, it
might meet with political opposition. For example, the higher
education community might object out of a concern that legislators
would make up for the forgone tax revenues by reducing state
expenditures on higher education.
--------------------
\22 Three of the states with tuition prepayment programs--Alaska,
Florida, and Wyoming--do not have a state income tax.
INDIRECT EFFORTS TO ATTRACT
LOWER-INCOME PURCHASERS
---------------------------------------------------------- Chapter 3:3
Rather than taking any special steps specifically intended to
increase lower-income participation, such as targeted advertising,
program officials have mainly tried to attract lower-income families
by making prepaid benefits affordable to all state residents.\23 Some
officials said that their programs had been designed from the
beginning to make it possible for lower-income families to
participate, through features such as low-priced benefits and
long-term payment plans. Emphasizing these features in brochures and
advertisements is the primary way some state tuition prepayment
programs try to appeal to lower-income families. Following are some
examples of these features in the programs we studied.
In Pennsylvania, program designers broke down tuition benefits into
"units," equivalent to one-twentieth of a credit hour,
specifically so that lower-income families could more easily
afford the program. During the program's first year of
operation, the average cost of one tuition unit for community
colleges was only about $3.00. Pennsylvania's state Treasurer
stated that the program offers "even the most financially
strapped families a mechanism to provide for their children's
higher education."\24
Wyoming and Michigan both worked with financial institutions to
create special loan programs enabling people to borrow the money
needed to purchase a contract, even though they might not have
had the kind of collateral that would be required for many
traditional loans. With these "secured" loans, the prepaid
contract itself served as collateral, to be held by the program
until the loan was repaid. Also, in its third year of sales,
Michigan added monthly payment plan options that allowed
contract purchasers to spread out their payments over periods of
up to 10 years.\25
Florida and Alabama both offer long-term payment options, allowing
purchasers to finance a prepaid tuition contract with monthly
payments from the time of purchase until the child reaches
college age. In addition, Florida offers a 2-year community
college contract, which is much less expensive than the 4-year
state university contract.\26 In Florida's 1993-94 enrollment
period, the parent of a newborn could purchase a community
college contract for just $11 per month using the long-term
payment plan.
In Alaska, citizens can have the state automatically direct up to
half of their annual Permanent Fund dividend toward the advance
purchase of tuition credits. Parents can even arrange for a
portion of their dependent children's dividends to go to the
tuition prepayment program. In recent years, the dividend has
been about $900 per person. The Director believed this unique
source of income, and the ease with which it can be used to
purchase tuition credits, might give Alaska's program a greater
proportion of lower-income families than other states' programs.
Officials have mixed views on the potential impact these kinds of
program features might have on lower-income participation levels. On
one hand, some officials are not very optimistic about the likelihood
of substantially increasing the proportion of lower-income families
participating in state tuition prepayment programs. These programs
are intended primarily to help middle-income families, they said, and
most lower-income families simply lack the discretionary income to
save for their children's college educations. One director even
expressed concern that it would be wrong to encourage lower-income
families to sign up for a program that might require too great a
financial sacrifice.
On the other hand, some officials believe that although it may not be
possible for many lower-income families to prepay the cost of 4 full
years of tuition at a state university, certain features--especially
selling benefits in small units--can help make it possible for some
lower-income families to participate in the programs to a lesser
degree. From this perspective, even paying for one semester of
tuition in advance would be a good thing for these families to do,
because it could help get their children thinking ahead about
college, looking forward to it as part of their future.
--------------------
\23 Interestingly, however, two officials mentioned a goal of
increasing minority participation. To the extent that minorities
have lower incomes than whites, efforts to increase minority
participation could also increase lower-income participation.
\24 Catherine Baker Knoll (remarks prepared for the Third Annual
Conference of the College Savings Plans Network, New Orleans, July
8-9, 1994).
\25 One study, however, found that the availability of these
long-term payment plans did not significantly change the income
distribution of participants in Michigan's program. The author
conjectures that the monthly payments were simply too high for most
lower-income families; the lowest monthly payment for a contract
covering four years of tuition was $112. See Jeffrey S. Lehman,
"The Distribution of Benefits From Prepaid Tuition Programs: New
Empirical Evidence About the Effects of Program Design on Participant
Demographics," Prepaid College Tuition Plans: Promise and Problems,
ed. Michael A. Olivas (New York: College Entrance Examination
Board, 1993), p. 28.
\26 Depending on the child's age and the payment plan chosen, a
community college contract is only about one-third to one-quarter of
the cost of a university contract. Furthermore, the community
college contract has been much more popular among lower- than
upper-income participants. During the program's first 5 years, about
13 percent of purchasers with incomes under $20,000 signed up for a
community college contract, compared with less than 2 percent of
those with incomes over $50,000.
DIRECT OUTREACH TO LOWER-INCOME
FAMILIES
---------------------------------------------------------- Chapter 3:4
Recognizing that many lower-income families will have difficulty
purchasing tuition benefits for their children, but believing that
ownership of such benefits will have a positive impact on these
children's educational experiences, some states have tried other ways
to get prepaid tuition benefits into the hands of needy children--for
example, by awarding prepaid tuition scholarships. However, some of
these initiatives, described in the following paragraphs, have not
yet lived up to their potential.
Florida established a program to give prepaid tuition scholarships
to low-income and at-risk students who might not otherwise be
able to afford a college education. The program was initially
funded by a $1.2 million state appropriation and an equal amount
in matching funds raised from private contributions. Thus far,
the program has succeeded in awarding scholarships to about
1,000 children throughout the state.
Michigan also established a prepaid scholarship program, which
received a state appropriation of $100,000 in 1991. After
officials raised an equal amount in matching funds, they were
able to award scholarships to 10 students who had qualified for
state-based financial aid but did not receive any because the
funds had been depleted. The state appropriated another $50,000
for the scholarship program in 1993, but the money was
contingent on 3:1 matching funds, which officials were unable to
raise.
Alaska also created a program to provide prepaid tuition
scholarships for needy students, paid for out of excess funds
generated by the tuition prepayment program. Unfortunately,
however, the prepayment program has not been able to achieve a
surplus.
Alabama established a prepaid scholarship program similar to
Florida's, but officials have not had the resources to get it up
and running. In addition, the Office of the State Treasurer
worked out an agreement with a bank whereby a small percentage
of the profits from a certain credit card would go toward
prepaid scholarships for foster children. But until now, other
cards have offered lower initial interest rates and, in
marketing the card, it has been difficult to target consumers
with an affinity for the groups who stand to benefit from the
profits. Thus, with relatively few people using the card, very
little money has been accumulated toward prepaid scholarships.
INCREASING PARTICIPATION AMONG
LOWER-INCOME FAMILIES WILL BE
DIFFICULT
---------------------------------------------------------- Chapter 3:5
Notwithstanding some of the efforts to make program participation
affordable to families from all income levels, it may be unrealistic
to expect significantly higher participation rates among lower-income
families. Tuition prepayment programs--and other college savings
programs as well--are primarily intended to help middle-income
families; those who have the ability to save, who will probably be
expected to pay for a significant portion of future college costs,
and whose children will likely not qualify for need-based grant aid.
However, the federal and state governments operate various financial
aid programs to assist lower-income families in financing a college
education.
In addition, lower-income participants appear to have more trouble
than others in meeting the financial commitment inherent in some
tuition prepayment programs, especially those that sell contracts
with fixed payment schedules. Our analysis of Florida's program
found that the lower the purchaser's income, the less likely he or
she is to fulfill the terms of the contract (see fig. 3.4). Of all
the people who signed up to purchase tuition contracts in the first
five enrollment periods (through January 1993), about 28 percent of
those with incomes under $20,000 had cancelled out of the program by
September 1993. In contrast, for purchasers with incomes over
$50,000, the cumulative cancellation rate was only about 10 percent.
Figure 3.4: Cancellation Rates
for Tuition Contracts Purchased
From Florida's Prepayment
Program, by Income Level
(See figure in printed
edition.)
Source: Florida program officials.
Nonetheless, when it comes to attracting families with modest
incomes, tuition prepayment programs may do at least as well as, if
not better than, many other college savings options in both the
public and private sectors. For example, limited data on the income
levels of participants in three states' college savings bond programs
show that lower-income families are significantly underrepresented,
and upper-income families overrepresented (see fig. 3.5). In Texas,
for example, only about 2 percent of 1991 bond purchasers had
household incomes less than $25,000, compared with about 39 percent
of state households with children under age 18; in contrast, about 41
percent of purchasers had incomes over $65,000, compared with 15
percent of state households with children. We found similar results
for both Connecticut and New Hampshire.\27
Figure 3.5: Income Levels of
College Savings Bond Buyers in
Three States, Compared With All
Households in These States
(See figure in printed
edition.)
Note: Percentages may not add to 100 because of rounding. Sampling
errors for CPS estimates do not exceed plus or minus 8 percentage
points.
Sources: Connecticut Treasurer's Office, Texas Veterans Land Board,
New Hampshire Family College Savings Plan, and Bureau of the Census'
1989 and 1992 Current Population Surveys.
As for another type of state initiative--Kentucky's program, in which
parents establish special college savings accounts--a 1991 survey of
participants found that the median gross family income was $50,000.
In contrast, according to data from the Census Bureau, the median
gross family income for all Kentucky households with children under
age 18 was $28,020.
And as for options in the private sector, the College Savings Bank,
which sells CDs indexed to increases in college costs, also draws its
depositors disproportionately from middle- and upper-income groups
(see fig. 3.6). A survey of its clients found that in 1991 only
about 3 percent had pre-tax household incomes under $25,000, while
about 78 percent had incomes of $50,000 or more, including about 28
percent with incomes of $100,000 or more.\28
In contrast, about 33 percent of all American households with
children under age 18 had total incomes of under $25,000, about 30
percent had incomes of $50,000 or more, and only about 4 percent had
incomes of $100,000 or more.
Figure 3.6: Income Levels of
College Savings Bank
Depositors, Compared With All
U.S. Households With Children
Under 18
(See figure in printed
edition.)
Note: Percentages may not add to 100 because of rounding. Sampling
errors for CPS estimates do not exceed plus or minus 1 percentage
point.
Sources: College Savings Bank and Bureau of the Census' 1992 Current
Population Survey.
--------------------
\27 These are the only three states for which we found income data on
college savings bond buyers. However, we cannot be sure whether the
data are representative of all bond buyers in these states: the
numbers of respondents in Connecticut and Texas were not reported;
New Hampshire's data were based on only 90 respondents out of 1,856
buyers.
\28 These percentages are based on responses by approximately 980 of
the 5,750 households participating in the savings program at the
time, and we cannot be sure whether these respondents are
representative of all participants.
MAJOR ISSUES CONCERNING STATE
TUITION PREPAYMENT PROGRAMS
============================================================ Chapter 4
From the beginning, state tuition prepayment programs have received
mixed reviews, with critics and supporters voicing a wide range of
arguments for and against these programs. Some of the most commonly
discussed issues have been whether the programs have a negative
impact on students' choices regarding college attendance, provide an
unnecessary benefit to middle- and upper-income families, are a good
investment for purchasers, and pose too much risk for states. An
overriding issue, however, has been the potential applicability of
federal tax provisions. This is the most significant problem or
barrier that state officials told us they encounter in trying to
establish and operate a tuition prepayment program.\29 Nearly 8 years
after the first such program started operating, state officials are
still uncertain about the federal tax liability of the participants
as well as the programs themselves. Applying certain tax provisions,
state officials say, will make it considerably more
difficult--perhaps even impossible--for these programs to succeed.
--------------------
\29 Additional problems that program officials mentioned in
interviews are summarized in app. II.
POTENTIAL IMPACT ON STUDENT
CHOICE
---------------------------------------------------------- Chapter 4:1
One issue concerning state tuition prepayment programs is that they
might limit or bias students' educational choices. Some critics have
argued that by purchasing tuition benefits in advance, parents lock
their children into attending a limited set of public colleges.
Also, some have argued that because these programs guarantee to fully
cover future costs only at in-state public colleges, beneficiaries
will feel pressured to enroll in one of these schools, even though
they may have sound personal or educational reasons to enroll at an
in-state private or out-of-state college.
The notion that beneficiaries in these programs can only attend
in-state public colleges is not supported. Our review of the rules
governing existing state tuition prepayment programs found that, in
general, benefits are portable to nonparticipating institutions; that
is, beneficiaries may apply the value of their prepaid benefits
toward the cost of attending in-state private and out-of-state
colleges (see table 4.1).
Table 4.1
What Happens If a Beneficiary Chooses to
Attend a Nonparticipating College?
---------------------------------- ----------------------------------
Alabama Program pays to student's chosen
school the average current in-
state rate for tuition and fees or
the amount the school charges,
whichever is less.
Alaska Student receives refund in amount
of in-state tuition rate or cash
value of account, whichever is
less. Refund check is made out
jointly to student and chosen
school.
Florida For in-state private colleges,
program pays value of in-state
public tuition to student's chosen
school. For out-of-state colleges,
program pays to student's chosen
school the in-state tuition rate
or the purchase price plus 5
percent interest, compounded
annually, whichever is less.\a
Michigan Students can either direct payment
to chosen school or request a
refund. For in-state private
schools, program pays the weighted
average tuition of in-state 4-
year public colleges; for out-of-
state schools, program pays the
nonweighted average tuition of in-
state 4-year public colleges. For
students who request a refund,
program pays designated recipient
the lowest tuition charged by a 4-
year Michigan public college.\b
Ohio Program pays to beneficiary the
weighted average tuition of in-
state public schools.
Pennsylvania Program pays to chosen school the
lesser of (1) the school's tuition
rate, (2) the actual tuition for
the number and type of credits
purchased, or (3) the value of the
student's account.
Wyoming Student must cancel contract, but
receives refund of purchase price
plus 4 percent interest,
compounded annually.
----------------------------------------------------------------------
\a Rule in effect since 1993; previously, benefits were not portable
out of state. Also applies only to baccalaureate-granting schools,
not out-of-state community colleges.
\b Rule for the full-benefits contract, which was purchased by about
96 percent of program participants.
It may be true that some beneficiaries will decide to enroll at an
in-state public college simply because their tuition costs at such
schools will be fully covered by their prepaid benefits. However,
students might make similar decisions if they were to accumulate the
same amount of money for college through any other means, such as a
state college savings bond, a CD, or a stock mutual fund. Budget
constraints commonly play a role in students' decisions about which
college to attend.
Although we did not try to determine whether beneficiaries who have
begun using their benefits felt constrained in choosing a college to
attend, we did learn that in four states, many program beneficiaries
have applied the value of their prepaid tuition benefits toward the
cost of attending nonparticipating colleges.\30
In Alabama, of the approximately 600 beneficiaries who used their
benefits in the fall of 1994, at least 14 percent were attending
an in-state private or out-of-state school.
In Florida, of the 12,093 beneficiaries who used their prepaid
tuition contracts in 1994, about 2 percent attended an in-state
private college and about 3 percent attended an out-of-state
college.
In Michigan, of the 4,063 beneficiaries who were enrolled in
college in the fall of 1994, about 18 percent were attending an
in-state private or out-of-state school and had arranged for the
program to send the dollar value of their contracts directly to
their chosen school.\31
In Ohio, of the beneficiaries who began using their benefits by the
fall of 1994, about 10 percent had enrolled at private in-state
schools and about 11 percent used their benefits at an
out-of-state school.
Finally, on the basis of college attendance patterns, it seems very
likely that most beneficiaries would choose to attend an in-state
public college even if they were not participating in a state tuition
prepayment program. In the fall of 1992, for example, about 72
percent of all first-time college freshmen in the United States were
enrolled in a public 2- or 4-year college in their home state (see
fig. 4.1). Furthermore, in most of the seven states with tuition
prepayment programs, the percentage of first-time freshmen enrolled
at in-state public colleges was close to the national average.
Figure 4.1: Most First-Time
Freshmen Attend a Public
College in Their Home State
(See figure in printed
edition.)
Source: U.S. Department of Education, National Center for Education
Statistics, Integrated Postsecondary Education Data System, 1992 Fall
Enrollment Survey.
--------------------
\30 In the remaining three states, substantial numbers of
beneficiaries have not yet enrolled in college.
\31 These figures include all three types of MET prepaid contracts.
PROGRAMS MAINLY HELP MIDDLE-
AND UPPER-INCOME FAMILIES
---------------------------------------------------------- Chapter 4:2
Another issue surrounding these programs is that they appeal to
mostly middle- and upper-income families. Some critics point out
that these programs do little to help lower-income families finance a
college education, and should not "take away from the primary goal we
have of public policy, which is basically to equalize
opportunity."\32 In addition, some have raised equity concerns
because of the subsidies that these programs may provide to
participants. Supporters argue, however, that not every government
program must redistribute wealth from the rich to the poor, and that
increased saving by middle-income families will reduce their need for
financial aid, thus making more of these resources available to
lower-income students.
Our work showed that state tuition prepayment programs can provide
various subsidies to participants. First, the discount prices
offered by the programs in Michigan and Alabama represent a subsidy
to participants on top of what they would receive through state
subsidization of higher education. A second subsidy can come in the
form of state expenditures for program operations. For example, (1)
Alabama's program received $500,000 in start-up costs, which it was
not required to repay;\33 (2) Ohio's program received a $1 million
appropriation in 1994 for operating expenses; and (3) Alaska's
program does not collect enough in participant fees to fully cover
its administrative costs, so these expenses--currently about $200,000
per year--are paid mostly out of unrestricted university funds.
Potential tax advantages represent a third type of subsidy to
participants. Currently, purchasers are not required to pay federal
income taxes annually on the increased value of their investment in
the program; instead, beneficiaries are liable for federal taxes on
the increased value of their benefits at the time of redemption.\34
Some states have also granted tax advantages to program participants.
For example, in Alabama, Ohio, and Pennsylvania, beneficiaries are
not required to pay state income taxes on the increased value of
their benefits at the time of redemption. And in Michigan,
purchasers are allowed to deduct the amount of their payments for
state income tax purposes.
Some programs, however, operate without some of the subsidies
mentioned. Most programs have priced their benefits close to the
current cost of tuition, some slightly higher. In Ohio, for example,
prepaid tuition credits are now priced about 8 percent above current
tuition prices, and previously were priced about 35 percent above
current prices. The programs in Ohio, Florida, and Michigan repaid
the initial state appropriations (ranging from $300,000 to about $1
million) they were given as start-up funds. And in Alabama, staff
salaries and other operating costs are now covered with application
and other administrative fees paid by participants.
Furthermore, not all government subsidies are equitable in the sense
that lower-income families benefit to the same extent as middle- or
upper-income families. Sometimes, however, subsidies to certain
income groups are, in a sense, balanced by different subsidies to
other income groups. For example, while the mortgage interest
deduction helps primarily middle- and upper-income families, there
are also various housing subsidies for the poor. Similarly, while
subsidies involved in state tuition prepayment programs primarily
benefit families who are relatively well off, state and federal
governments also subsidize higher education for lower-income families
through various financial aid programs.
Regarding whether these programs will free up substantial financial
aid dollars for lower-income students, our review of federal
financial aid rules and data from six major universities indicated
that this probably will not occur. First, the vast majority of
current beneficiaries do not appear to need financial aid. Most of
them do not apply for aid, and those who do typically do not qualify.
For example, of the 789 beneficiaries enrolled at Florida State
University in 1993-94, 86 percent did not apply for aid, and of those
who did, 72 percent were determined not to need assistance because
(1) they and their parents had enough money--not even counting the
value of their prepaid benefits--to cover all college costs, or (2)
the combination of their family resources and merit aid, such as
scholarships, exceeded anticipated costs (see table 4.2).
Table 4.2
Most Prepaid Beneficiaries Appear Not to
Need Financial Aid--Data From Six
Participating Institutions
Percent who Of those
Number of did not who did
prepaid apply for apply,
students financial percent
Institution enrolled aid ineligible
------------------ ------------ ------------ ----------
Eastern Michigan 163 85 46
University\a
Michigan State 925 78 60
University\b
Florida State 789 86 72
University\b
University of 1,864 40 77
Florida\b
University of 692 74 35
Central Florida\b
Ohio State 103 49 53
University\a
----------------------------------------------------------
\a Data for 1994-95 academic year.
\b Data for 1993-94 academic year.
Source: Estimates provided by financial aid offices at these six
institutions.
Second, although federal financial aid rules have the effect of
reducing the amount of aid that prepaid beneficiaries can receive,
this will not translate into savings that can be passed along to
other, potentially more needy students. Once the value of their
prepaid benefits is taken into account, beneficiaries typically are
eligible for a smaller guaranteed student loan than they would have
been otherwise; for some, the aid reduction may mean not qualifying
for a loan at all. But the money that goes unborrowed by prepaid
students does not then become available to other students, because,
unlike grants, there is no fixed amount of money allocated each year
for guaranteed student loans. Rather, lenders will provide loans to
as many students as qualify.
--------------------
\32 Arthur Hauptman, comments made at the Invitational Conference on
College Prepayment and Savings Plans, in Denver, July 7-8, 1987; see
conference proceedings (New York: College Entrance Examination
Board), p. 67.
\33 However, the board that oversees the program may decide to repay
this money in the future, according to the program's Director.
\34 We discuss the perceived importance of these tax breaks for
participants and the programs themselves later in this chapter.
INVESTMENT VALUE FOR PURCHASERS
---------------------------------------------------------- Chapter 4:3
A third issue concerning these programs is their value as an
investment option. One common criticism is that purchasers could
lose some or all of the interest on their principal if (1) the
beneficiary does not to go to college at all or attends a
nonparticipating college; (2) the purchaser withdraws from the
program; or (3) the program is terminated. Some critics have also
argued that even if beneficiaries do use their benefits as intended,
purchasers can simply earn a higher return from other investments,
such as stocks. Supporters, on the other hand, argue that these
programs (1) have resources and expertise that enable them to invest
more effectively than the average family can on its own; (2) provide
an easy and affordable way to save for college; (3) offer a unique
psychological benefit--peace of mind--because of the guarantee to
cover future costs; and (4) may have tax advantages over other
investment options.
To determine whether purchasers could potentially earn a better
return on their money from other investment vehicles than from
tuition prepayment programs, we compared the effective annual rate of
return on large company common stocks with the effective annual rate
of inflation for tuition and fees at public universities over more
than a dozen 15-year periods, up to 1993.\35 Over most of these
periods, the stocks provided a higher rate of return than the rate of
tuition inflation for public universities (see fig. 4.2).
Figure 4.2: Tuition Increases,
Compared With Returns on Stocks
Over 15-Year Periods
(See figure in printed
edition.)
Sources: SBBI 1994 Yearbook (Chicago: Ibbotson Associates) and U.S.
Department of Education.
However, while parents could earn a higher return from other
investment vehicles, it is not at all certain that they would. With
alternate investment options, parents take the risk that they may not
end up with enough money when their children are ready to enroll in
college. Even stocks have not always kept pace with tuition
increases at public universities. For example, as shown in figure
4.2, during the 15-year periods ending in 1980 to 1983, tuition
inflation exceeded the effective rate of return on large company
common stocks. Thus, parents beginning to save for their children's
college educations in 1965-68 would have done better by joining
tuition prepayment programs, had they existed, than by investing
solely in stocks.
To beat the tuition inflation rate over the long run, investors would
need to (1) put the right amount of money in the right investment
vehicles at the right time and (2) not use the money for other
purposes before their children reach college age. Would the
participants in state tuition prepayment programs make the correct
investment choices? On the basis of evidence from one state, it
seems likely that many would not. When asked on Alabama's program
application how they would save for college costs without the tuition
prepayment program, about 52 percent of purchasers in 1991-94 checked
"savings account," about 17 percent checked "savings bonds," about 15
percent checked "life insurance," and only about 6 percent checked
"stocks."\36 With passbook savings accounts currently offering
interest rates of less than 3 percent, it appears that a large
percentage of Alabama's participants would be putting their money in
investments that would be expected to provide a lower return than the
anticipated rate of tuition inflation, about 7 percent to 8 percent
per year.
Purchasers apparently see the risk of losing some of the interest
they accumulate in tuition prepayment programs as outweighed by other
benefits of program participation. Limited evidence to support this
position comes from a 1992 report by the Florida Auditor General's
office, which asked a sample of purchasers to describe what they saw
as the advantages and disadvantages of the state's tuition prepayment
program. As for the disadvantages, 35 percent of participants
referred to losing interest on the money paid into the program if the
beneficiary did not use the prepaid benefits at all, and 11 percent
mentioned that beneficiaries could not use their benefits at an
out-of-state college.\37 Many more participants, however, identified
various advantages of the program: About 67 percent mentioned the
guarantee to cover future educational costs with payments based on
today's prices; 42 percent mentioned that paying now instead of later
gave them peace of mind; and 33 percent referred to the availability
of easy, affordable payment options.\38
Finally, regarding the tax advantages that these programs may have
over other investment choices, certain advantages could be eliminated
in the future. We discuss this possibility in greater detail in the
final section of this chapter.
--------------------
\35 The effective rate of return, also sometimes referred to as the
annualized rate of return, is greater than the simple arithmetic
average of individual interest rates, because it includes compounding
during the investment period.
\36 The remaining 11 percent checked "other." Source: Data provided
by Alabama program officials.
\37 At the time of the survey, beneficiaries who wanted to attend an
out-of-state college would have received the principal from their
contracts, but no interest.
\38 Office of the Auditor General, State of Florida, Performance
Audit of the Florida Prepaid Postsecondary Education Expense Program,
Report No. 11825 (Mar. 25, 1992). Responses cited are for
participants whose designated beneficiaries had not yet enrolled in
college. Response totals exceed 100 percent because respondents were
allowed to cite more than one advantage and disadvantage.
RISK TO STATES
---------------------------------------------------------- Chapter 4:4
A fourth major issue surrounding state tuition prepayment programs is
the degree of risk they pose for states. A key criticism is that
they may not earn sufficient investment returns, thus leaving the
state with a large, unfunded liability. A program shortfall, or even
the threat of one, could lead to many undesirable outcomes, such as a
taxpayer bailout, reduced spending on higher education, or
lower-than-anticipated tuition increases at state colleges. In
contrast, supporters claim that the risk of a shortfall can be
minimized, so long as the programs properly price their benefits;
make sensible actuarial assumptions; and develop a diversified,
though aggressive, investment portfolio. Some also argue that
safeguards can be adopted to protect against excessive losses, such
as an "escape clause" that allows the state to suspend or terminate
the program quickly if it is determined to be actuarially unsound.
We found two instances in which tuition prepayment programs were
suspended because they appeared headed for financial trouble. First,
Duquesne University, a private institution in Pittsburgh,
Pennsylvania, implemented its own tuition prepayment program in 1985
but suspended it just 3 years later, because investment returns were
running lower than expected and the school wanted to raise tuition
faster than originally anticipated. Second, Michigan's tuition
prepayment program stopped selling new contracts after 3 years, at
least in part because of state officials' concerns about its ability
to meet its future obligations.\39 The Director explained that MET's
investment returns had dropped somewhat, making it harder to keep up
with state tuition inflation--especially because the program was also
required to pay federal taxes on its earnings. However, the program
Director also pointed out that the program is still actuarially
sound.
The experiences of Duquesne and MET may help other program officials
avoid similar problems. For example, both programs offered deep
discounts on contracts for younger children. According to one
analysis of Duquesne's program, in 1986 the cost of a 4-year contract
for a child planning to begin college in the year 2000 was $9,182,
while the cost of tuition for the 1986-87 academic year alone was
$6,270.\40 Such low prices mean that investment returns must not only
keep pace with but substantially exceed the rate of tuition
inflation. Most of the state programs, though, have not offered such
deep discounts and some have even charged prices slightly higher than
the current cost of tuition at participating colleges.\41
Finally, if a state tuition prepayment program were facing financial
trouble, it is unclear which, if any, of the predicted outcomes would
occur. In addition, whether these outcomes would be negative is a
matter of opinion; what one observer sees as unacceptable might be
acceptable to another. For example, some people might oppose a state
bailout on equity grounds, as a subsidy to relatively well-off
families. In contrast, the Michigan Treasurer who helped develop MET
once said, "So we go through that horrible scenario of the state
government bailing out a system so 10,000 kids can go to college.
But what better way to spend the taxpayers' dollars than on educating
kids? The worst is that we're spending more money on education than
we might have been planning instead of spending it on dredging some
lake that some legislator sits on."\42 Similarly, requiring state
colleges to keep down their tuition prices could be seen as impeding
the colleges from carrying out their educational mission or as
helping to keep college affordable and accessible to families of
modest means.
--------------------
\39 Some MET supporters have argued that the suspension was also
politically motivated.
\40 Presentation by John Finnerty at the Invitational Conference on
College Prepayment and Savings Plans, in Denver, July 7-8, 1987; see
conference proceedings (New York: College Entrance Examination
Board), pp. 25-31.
\41 Programs' efforts to avoid the tax liability that contributed to
MET's problems are described later in this chapter.
\42 Robert Bowman, comments made at the Invitational Conference on
College Prepayment and Savings Plans in Denver, July 7-8, 1987; see
conference proceedings (New York: College Entrance Examination
Board), pp. 18-19.
APPLICABILITY OF FEDERAL TAX
PROVISIONS
---------------------------------------------------------- Chapter 4:5
The most serious issue facing state tuition prepayment programs,
according to program officials, is the potential applicability of
federal tax provisions. Which provisions apply now, or may apply in
the future, is unclear. Program officials are particularly troubled
by the possibility that IRS will require (1) programs to pay taxes on
their investment earnings and (2) participants to pay taxes annually
on program benefits.\43
--------------------
\43 This section presents a brief overview of federal tax issues; a
more complete discussion is presented in app. III.
MICHIGAN'S HISTORY OF TAX
PROBLEMS
-------------------------------------------------------- Chapter 4:5.1
Much of the concern over federal taxation stems from the experience
of Michigan's pioneering program. Before MET sold any contracts, it
requested a ruling from IRS on the applicability of federal tax
provisions. IRS ruled in March 1988 that (1) purchasers may be
liable for the federal gift tax, (2) beneficiaries would be liable
for federal income taxes on the increased value of their benefits at
the time of redemption, and (3) MET itself would have to pay federal
taxes on its investment earnings. Although some observers saw the
ruling as unfavorable--especially the requirement that MET pay taxes
on its investment earnings--the program began selling prepaid tuition
contracts in the fall of 1988.
In 1991, however, when lower investment returns made it more
difficult to stay ahead of tuition inflation, MET suspended sales and
requested a full refund of the $15.8 million it had paid in taxes for
its first 3 years of operation. When IRS denied the refund request,
MET and the state of Michigan sued the United States, arguing that
the program's investment earnings were exempt from federal taxes
because the program is an integral part of the state. MET lost in
U.S. district court in July 1992, but won its appeal in the Sixth
Circuit Court of Appeals in November 1994. Although IRS disagreed
with the Circuit Court's decision, the Solicitor General recently
decided not to appeal the case to the U.S. Supreme Court.
SOME STATES DEFER ACTION
BECAUSE OF TAX CONCERNS
-------------------------------------------------------- Chapter 4:5.2
After the IRS ruled on MET, several states that had been interested
in starting tuition prepayment programs backed away from the idea.
Indiana decided not to implement such a program after receiving its
own ruling from IRS in September 1988, which indicated that the
proposed program would be subject to federal taxes on its investment
earnings. One state official said, "We didn't feel that we could
keep up with tuition costs that are rising about 9 percent a year.
We would have to earn a return of around 13 percent before taxes to
get 9 percent after taxes."\44
Also, 1994 legislation authorizing a tuition prepayment program in
Virginia stipulated that it cannot begin selling contracts until IRS
rules that the program's investment earnings are exempt from federal
taxation.
--------------------
\44 Cited in Jacqueline Mitchell, "Michigan Flunks Its Tuition Trust
Fund," Wall Street Journal (Mar. 26, 1992), p. C16.
EFFORTS TO AVOID TAX ON
PROGRAM EARNINGS
-------------------------------------------------------- Chapter 4:5.3
In light of Michigan's experience, states that implemented programs
have tried to structure them more clearly as an integral part of the
state. For example, in some states the program is within and under
the direct control of the state Treasury Department, and in others
the program is administered by the state's higher education system.
Thus far, IRS has emphasized that backing these programs with the
full faith and credit of the state may help protect their investment
earnings from federal taxation, because it demonstrates the state's
financial stake in the program. However, some officials told us that
their states have not taken this step because it is prohibited by
their state constitutions. Florida's program is the only one to
operate with the full faith and credit of the state from its
inception. By statute, in the event of a shortfall, the legislature
must provide the program with the funds it needs to meet its
obligations. Also, in 1994, Ohio citizens approved a constitutional
amendment that enabled the state to back the tuition prepayment
program with its full faith and credit.
ANNUAL TAX LIABILITY FOR
PARTICIPANTS ALSO A CONCERN
-------------------------------------------------------- Chapter 4:5.4
Although IRS rulings apply only to the parties who request them,
program officials in other states have generally interpreted IRS's
ruling on the tax consequences for MET purchasers and beneficiaries
as applicable to their programs, too. And, in general, these
provisions are not considered a hindrance to successful program
operation. But program officials are concerned that IRS may change
its opinion on the tax liability of program participants.
Specifically, IRS has indicated that regulations on contingent debt
recently proposed by the Department of the Treasury could be
interpreted as applying to tuition prepayment programs. This
interpretation could result in either purchasers or beneficiaries
being liable for federal income taxes annually on the imputed
interest on their investment in these programs.
Program officials believe that such a tax would hurt program
operations. First, they argue that purchasers would not understand
or be receptive to paying taxes on income they had not personally
received (sometimes referred to as "phantom income"), and as a
result, program sales would decrease significantly. Second, they
claim that notifying participants of this tax liability every year
would be an administrative burden. Some program officials recently
expressed these views in letters to IRS and in testimony before IRS
and Treasury officials on the proposed regulations.
SOME PROGRAMS AWAITING IRS
RULINGS
-------------------------------------------------------- Chapter 4:5.5
Like Michigan, some of the other states with tuition prepayment
programs also requested IRS rulings to clarify their federal tax
consequences. But none of the states has received a ruling; Florida
and Ohio have been waiting 5 years. IRS officials told us that
rulings on other programs would likely be delayed while the MET case
was in litigation. However, even though litigation concerning MET
has now ended, rulings on other programs may not be immediately
forthcoming, and tax questions could remain unanswered even longer.
For example, IRS may wait until Treasury issues the final regulations
on contingent debt, expected late this summer, because they could
determine how IRS rules on the federal taxes applicable to program
participants. In addition, IRS could audit an existing program that
it believes is liable for federal taxes on its investment earnings.
If ordered to pay these taxes, the program might then challenge IRS
in court, further postponing the issuance of rulings while the case
is in litigation.
CONCLUDING OBSERVATIONS
============================================================ Chapter 5
In response to rapidly rising costs of higher education, several
states have implemented tuition prepayment programs. These programs
are intended to ease families' concerns that they will not have
enough money in the future to cover the costs of their children's
college educations. Each of the seven programs we reviewed is
uniquely designed and structured, although they all operate in a
generally similar manner.
Judging by their overall participation rates, the programs have had
varying degrees of success. However, the programs are fairly new and
are still learning how best to package and market their benefits and
reach potential purchasers. Most participants in these programs are
from middle- or upper-income families--families that can afford to
save and will be expected to pay for a significant proportion of
their children's future college expenses. These programs are
probably not a viable option for most lower-income families.
In deciding whether to establish a tuition prepayment program, and in
later operating such a program, states face a variety of issues and
potential problems. For example, there have been long-running
debates over what effect these programs might have on beneficiaries'
educational choices and the degree of risk they pose to states. Some
of the issues represent matters of opinion and differing philosophies
and therefore cannot be resolved through empirical analysis.
Regarding the issue of federal taxation, nearly 8 years after
Michigan first raised questions about the applicability of various
federal tax provisions to these programs and their participants, the
issues are still unresolved. This constitutes a significant problem
for these programs, because certain tax consequences can have a
negative impact on program operations. Officials in some states are
concerned about which tax provisions apply to their existing
programs, and officials in other states have deferred implementation
of such programs pending more clarification of the tax issues.
Furthermore, if state officials have to wait for IRS and the courts,
several more years could pass before some resolution is reached--and
there is no guarantee the resolution will be favorable.
On one hand, federal legislation could significantly speed up
resolution of these issues and ensure that resolution is favorable.
For example, the Internal Revenue Code of 1986 could be amended to
exempt these programs' investment earnings from federal taxation and
to exclude purchasers and beneficiaries from having to pay federal
taxes annually on the imputed interest on their investments in these
programs. In fact, legislation addressing some of the tax issues
concerning these programs and their participants has been introduced
in the current Congress and in the past.\45
On the other hand, the problem of federal taxation could be resolved
in other ways. For example, IRS could issue a favorable letter
ruling for one or more programs, which might send a clearer message
to other states about what it takes to establish a program that IRS
considers an integral part of the state, and whose investment
earnings are exempt from federal taxation. IRS could even take a
different position on these issues than it did concerning MET.
Treasury officials could heed the comments of prepayment officials on
the proposed contingent debt regulations and either explicitly exempt
these programs from the regulations, or indicate to IRS that it
should not interpret them as applying to tuition prepayment programs.
In addition, before pursuing a legislative resolution, several other
factors would need to be considered. For example, what impact, if
any, would exempting these programs' investment earnings and
beneficiaries from annual federal taxation have on private sector
financial institutions and intermediaries? The head of the College
Savings Bank (see ch. 1) has argued that without creating similar
tax advantages for private sector college savings options, such
legislation would "distort investor choices" and "crowd out virtually
all private sector competition in the marketplace."\46
Enacting the kind of tax provisions favored by program proponents
could also have an uncertain impact on federal revenues. For
example, if the money purchasers spend on prepaid tuition benefits
would have otherwise been put in taxable investment vehicles, the
federal government would lose potential tax revenues. On the other
hand, exempting the programs' investment earnings might not be
considered a loss to the federal treasury, because the programs are
not paying taxes now on their interest income. Nonetheless, these
kinds of potential costs would have to be weighed against the
perceived benefits of legislation aimed at resolving the tax problems
currently facing state tuition prepayment programs.
--------------------
\45 See, for example, H.R. 1328, 104th Cong., and H.R. 2404, 100th
Cong.
\46 Peter A. Roberts, "Market-Based Solutions: Federal and State
Legislative Alternatives to Increase the Rate at Which Families Save
for College" (prepared statement presented at the Third Annual
Conference of the College Savings Plans Network in New Orleans, July
9, 1994).
AGENCY COMMENTS
---------------------------------------------------------- Chapter 5:1
We discussed a draft of this report with IRS officials, who agreed
with the discussion of federal tax issues concerning these programs.
Officials from all seven state tuition prepayment programs also
reviewed the information in this report, and they agreed with our
characterization of the issues and descriptions of their programs.
Where appropriate, we incorporated minor wording changes suggested by
IRS officials and state program officials.
OVERVIEW OF TUITION PREPAYMENT
PROGRAM FEATURES
=========================================================== Appendix I
The tuition prepayment programs in each of the seven states have in
common the guarantee that parents can "lock in" future college
tuition at today's program prices. However, each state's program is
unique in terms of the benefits offered and the rules governing
eligibility, benefit redemption, refunds, and so forth. This
appendix presents detailed descriptions of the programs in Alabama,
Alaska, Florida, Michigan, Ohio, Pennsylvania, and Wyoming.
ALABAMA
--------------------------------------------------------- Appendix I:1
Alabama enacted the Wallace-Folsom Prepaid College Tuition Trust Fund
Act in 1989, establishing the Prepaid Affordable College Tuition
program. Since 1990, the program has sold contracts guaranteed to
cover up to 4 years of undergraduate tuition and required fees at any
public college or university in the state, including 2-year and
4-year schools. There are 50 eligible institutions in the state.
The Alabama State Treasurer's Office administers the program, under
the guidance of a 10-member board of trustees. Contract payments are
received and invested in the Wallace-Folsom Prepaid College Tuition
Trust Fund.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:1.1
The tuition benefit covers up to 135 semester hours, or the
equivalent at schools on another academic term basis. The fee
benefit covers mandatory fees for 8 registrations on a semester
system, or 12 registrations on the quarter system, or the equivalent
number for schools on a different academic term basis.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:1.2
To qualify, beneficiaries must be in the eighth grade or less. They
must also be either a resident of Alabama or the child of a
noncustodial parent who is a resident. Children of military
personnel whose "home of record" is Alabama are also eligible. The
program allows only one purchaser per contract. However, people
other than the purchaser may make payments. Enrollment takes place
from May 1 through May 31 each year. The program charges a $75
nonrefundable application processing fee.
Purchasers can make a single payment for 4 years of tuition, or
choose one of two monthly payment plans. Under the 5-year payment
plan, purchasers make 60 equal monthly payments. This plan is only
available for beneficiaries in the sixth grade or less. The extended
payment plan calls for equal monthly payments from contract
initiation until the beneficiary reaches college age. For both
monthly payment plans, the program provides coupons, which the
purchasers send in with their checks. Payments can also be arranged
through automatic deductions from bank accounts or through direct
deposit from the purchaser's employer. Monthly payments begin
September 1 of each year; single payments are due July 1. Purchasers
may change their payment schedule during the enrollment period in
which the contract is initiated for a $15 fee. The window of
opportunity begins the month in which the contract is purchased and
ends the 15th day of the month when their first payment is due. The
charge for late payments is $15.
Purchasers who choose one of the monthly payment plans are permitted
to pay off the contract balance at any time. Purchasers can also pay
more than the required monthly payment amount at any time, which will
reduce the total number of payments, but not the monthly payment
amount. The contract must be fully paid off, including any
outstanding fees, before the beneficiary can use the benefits.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:1.3
Contract prices vary by the age of the beneficiary and the length of
time over which the contract will be paid off. In 1993, the single
payment for an eighth grade student was $7,961; for an infant the
price was $4,892. Under the 5-year payment plan, the monthly payment
for a sixth grader was $156; for an infant it was $105. The extended
payment plan cost $203 for an eighth grader and $50 for an infant.
The prices reflect the weighted average cost of tuition and fees at
state schools. Tuition and fees for 1992-93 ranged from $945 at
Wallace Community College to $2,269 at the University of Alabama,
Huntsville.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:1.4
Beneficiaries have 10 years from the projected date of enrollment to
use all benefits. Extensions may be granted for military service.
Beneficiaries must still meet in-state residency requirements for the
Alabama school they attend, regardless of the purchaser's residency
at the time of enrollment. If beneficiaries are ineligible for
in-state tuition, they must pay for any remaining costs.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:1.5
The program makes several allowances for benefits to be refunded,
transferred, or used at nonparticipating institutions. For example,
benefits can be used at any private or out-of-state institution. The
program sends to the institution an amount based on the average cost
of tuition and fees at Alabama's public 4-year colleges and
universities, or the cost of tuition and fees at the beneficiary's
school, whichever is less. The program charges $25 for each term
that the beneficiary uses the benefits at a nonparticipating school.
Beneficiaries may also transfer among any of the Alabama public
colleges and universities. For instance, a student may transfer to a
4-year institution after completing a community college. Also, a
student may transfer from one 4-year university to another.
If the beneficiary gets a scholarship, the program will pay the
school as if it had not been received, and then the purchaser can
request a refund from the institution for overpayment.
If a beneficiary starts college and then stops, the program will
refund the remaining benefits, minus a $150 cancellation fee. The
program will pay the refund to the beneficiary over a period of time.
However, once a beneficiary starts college, he or she may not
transfer the benefits to someone else. If the beneficiary decides
not to go to college, he or she may receive a refund of the unused
benefits.
Benefits may be transferred, instead of refunded, only if the
beneficiary has died, received a scholarship, or never enrolled in
school. Benefits can only be transferred to a younger member of the
beneficiary's immediate family, or another child, if approved by the
board, for a $55 fee.
Also, purchasers can cancel their contracts for a refund before the
beneficiary reaches college age. However, the program will deduct
cancellation and administrative fees, which includes the account
maintenance fees. The cancellation fee is 50 percent of the amount
paid into the fund or $150, whichever is less. However, no
cancellation fee is charged if the child dies or becomes disabled.
The purchaser will receive a refund of the current value of the
contract.
Ownership of the contract can be transferred by naming a new
purchaser, subject to written authorization of the original
purchaser. The transfer fee is $20, but this is waived if the
contract has to be transferred because of the death of the purchaser.
ADDITIONAL FEATURES
------------------------------------------------------- Appendix I:1.6
As an added feature for participating in the program, purchasers who
qualify can receive a lower interest rate on one particular credit
card. The "Alabama's Future Card" is a Visa card offered through
Colonial Bank, in a joint venture with the state. Purchasers can
receive a 15.5 percent annual percentage rate, while regular card
holders pay 16.9 percent. In addition, a percentage of all sales is
donated to the state of Alabama to benefit four programs for
children, including the Prepaid Affordable College Tuition program.
ALASKA
--------------------------------------------------------- Appendix I:2
Alaska established the Advance College Tuition program in April 1991,
and the program began selling tuition credits that fall. The tuition
credits may be used at the University of Alaska, the only state
university in Alaska, which includes three regional campuses and a
community college. The University of Alaska Board of Regents
administers the program.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:2.1
Participants purchase tuition credits toward undergraduate or
graduate education at the University of Alaska. For an undergraduate
degree, each tuition credit is redeemable for one undergraduate
semester credit hour. For graduate education, two tuition credits
are worth one graduate semester credit hour. It generally takes at
least 120 credit hours to complete a bachelor's degree. The number
of credits for a graduate degree varies according to the course of
study undertaken.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:2.2
Purchasers may be any person, institution, or business, and only one
purchaser may be named on each agreement. Purchasers must designate
a primary beneficiary, and also may name up to three alternate
beneficiaries in the event that the benefits are not used by the
primary beneficiary. Purchasers may name anyone they choose as
beneficiaries, regardless of their relationship to one another.
Purchasers may even name themselves as the beneficiary.
Neither purchasers nor beneficiaries are required to be residents
when applying to the program. However, to qualify for resident
tuition status at redemption, beneficiaries must have been a resident
of Alaska, or the child or legal ward of a resident or of an alumnus
of the university, when the agreement was established, at the time of
redemption, or any time in between.
To begin the program, purchasers must buy a minimum of six tuition
credits. Purchasers also pay a nonrefundable $50 contract initiation
fee. Thereafter, purchasers may buy a minimum of one credit per
purchase. Although new prices go into effect each January,
enrollment takes place year-round.
Purchasers can make payments at any time using checks or money
orders. In addition, they can also designate up to 50 percent of
their annual Permanent Fund dividend to purchase tuition credits.
Purchasers who are the legal guardian of a beneficiary may also use
the beneficiary's dividend to purchase tuition credits for that
child. Purchasers receive regular account statements to apprise them
of the account's progress.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:2.3
The program charges purchasers roughly the current cost of tuition at
the time they make each payment. Prices are adjusted each year to
reflect tuition increases. For instance, the cost of one tuition
credit in 1993-94 was $66; in 1994-95, a tuition credit was $71. The
cost of one tuition credit for the 1995-96 academic year will be $78,
making the single payment cost of 4 years of undergraduate education
$9,360.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:2.4
In order to use the tuition credits, beneficiaries must notify the
program at least 3 months prior to the time they plan to start
college. They must let the program know the number of credits they
plan to use, and indicate how many will be used for tuition. They
must also specify the institution they plan to attend. The program
will then issue the student a tuition waiver to be used at
registration. Beneficiaries may begin using credits 2 years after
joining the program. In addition, beneficiaries have up to 15 years
after their anticipated college enrollment date to begin using the
credits.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:2.5
The program allows purchasers and beneficiaries to receive refunds in
various amounts based on the reason for the refund. In addition,
alternate beneficiaries may use credits under certain circumstances.
Refund amounts are calculated in three ways--the cash value of the
credits, the tuition value, and the purchase price. The cash value
is the value of a tuition credit based on earnings and market value
of the fund investments, the outstanding tuition credits, and other
actuarial adjustments. Tuition value means the value of a tuition
credit based on a weighted average of the University of Alaska
resident undergraduate tuition rates. The purchase price means the
amount paid by the purchaser for tuition credits, not including any
investment earnings or outstanding fees.
Primary beneficiaries qualify for a refund of the cash value if they
become disabled. If the beneficiary dies, the estate of the primary
beneficiary will receive a cash-value refund, unless an alternate
beneficiary was named.
Primary beneficiaries qualify for a refund of the tuition value, not
to exceed the cash value, if they (1) attend a nonparticipating
institution, (2) fail to gain admittance into the University of
Alaska, (3) have unused credits after completing college, or (4) have
more than enough credits to graduate. In the latter two cases, the
refund only includes unused benefits.
If a beneficiary gets a full tuition scholarship, the plan will
reimburse the student at that year's fixed cost, for each semester he
or she has the scholarship. The value of the benefits can then be
used to pay for other costs of attendance, such as books,
transportation, and room and board. If a beneficiary gets a full
scholarship covering all costs of attendance, he or she may either
save the credits for graduate school or get a refund. If the
beneficiary chooses a refund, he or she will receive either the
amount that would have been spent for tuition or the value of a
tuition credit, which is based on the weighted average of the
University of Alaska resident undergraduate tuition rates, whichever
is less.
If the primary beneficiary quits college or decides not to go to
college, the program will refund the purchase price for any
unredeemed credits. Such refunds are paid out in four annual
installments to discourage requesting refunds for short-term cash
needs.
In most cases, if an alternate beneficiary is named, tuition credits
are transferred to the alternate, rather than refunded to the primary
beneficiary or his or her estate. For instance, if the primary
beneficiary dies, does not go to college, or fails to gain admittance
into the University of Alaska, the credits are transferred to an
alternate beneficiary. In addition, if the primary beneficiary does
not use any credits during any 6-year period after the anticipated
college enrollment date, the program notifies the primary beneficiary
that his or her credits will be transferred to the alternate
beneficiary. In other circumstances, if a primary beneficiary has
additional credits after finishing college or decides not to finish
college, the unused credits will be transferred to the alternate
beneficiary. Such a transfer leads to a 6-year extension of the time
frame for using benefits.
ADDITIONAL FEATURES
------------------------------------------------------- Appendix I:2.6
The program has two additional features to encourage higher education
attainment--graduation incentive awards and prepaid tuition
scholarships. The program funds both of these features by allocating
a portion of any excess amount of the prepaid tuition fund over the
actuarial requirements to a special account for them each year.\47
Beneficiaries may receive graduation incentive awards to encourage
them to continue and complete their college education. Beneficiaries
can earn one graduation incentive credit for each tuition credit
redeemed or refunded for payment of tuition at the University of
Alaska or any eligible institution. After a beneficiary earns a
degree or equivalent certificate, he or she can either redeem the
graduation credits toward graduate education or get refunds for a
variety of other uses.
Prepaid tuition scholarships offer an incentive for younger Alaskans
to achieve higher academic standards of performance in middle and
high school and to complete their secondary education. Scholarships
may be given to students in grades 6 through 12 who attend school in
Alaska, and they can only be used for attendance at the University of
Alaska.
--------------------
\47 According to program officials, these features are not yet
offered because the fund does not have any excess proceeds.
FLORIDA
--------------------------------------------------------- Appendix I:3
Florida enacted the Florida Prepaid Postsecondary Education Expense
Program in June 1987; the program began selling contracts for
undergraduate prepaid tuition in the fall of 1988. The benefits are
guaranteed to cover future education costs at Florida's 9 state
universities and 28 community colleges. The program is backed by the
full faith and credit of the state, meaning the state is required to
appropriate to the trust fund an amount necessary to meet the
program's obligations if the money in the trust fund is insufficient.
The program is administered by the Florida Prepaid Postsecondary
Education Expense Board, a state agency affiliated with the State
Board of Administration.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:3.1
The program offers three prepaid tuition plans, plus a prepayment
plan for dormitory space. Participants can prepay the cost of
undergraduate tuition and mandatory fees for 2 years at the community
college level, 4 years at the university level, or 2 years at
community college plus 2 years at a university. Purchasers of the
4-year university plan only can also prepay the cost of dormitory
space for up to 5 years. The dormitory contract covers the cost of a
double-occupancy, air-conditioned room.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:3.2
When the contract is purchased, the beneficiary must be a state
resident or the child of a noncustodial parent residing in Florida.
Children of military personnel for whom Florida is their "home of
record" are also eligible to participate. Beneficiaries must also be
below the twelfth grade.
Purchasers need not be a relative of the beneficiary; even
corporations, businesses, and civic and fraternal organizations can
purchase a contract. Two people may jointly purchase a contract, but
no provisions can be made for separate or split payments.
Beneficiaries can only have one tuition and dormitory plan. Prepaid
dormitory contracts are restricted to beneficiaries in the eighth
grade or lower. In addition, housing benefits are for fall and
spring semesters only; they may not be used during summer sessions.
For each benefit plan, the program offers three payment plan options:
(1) the single-payment plan, in which the contract is paid for with
one lump-sum payment; (2) the 5-year installment plan, in which
purchasers make 55 monthly payments; and (3) the monthly payment
plan, in which payments are made from the time of purchase until the
beneficiary's projected enrollment year. The 5-year installment plan
is only available to purchasers if the beneficiary is in the eighth
grade or lower. Monthly payments can be made by check or automatic
transfer. In addition, state employees and employees from some other
organizations can arrange to pay through payroll deductions.
The enrollment period is from mid-October through mid-January.
Purchasers must pay a nonrefundable $42 application fee per child.
Applications may be submitted to the program office or to any branch
of First Union National Bank, the approved agent for distributing
information on the program.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:3.3
The costs of prepaid tuition and dormitory contracts vary by the
benefit plan selected and the age of the beneficiary. Following are
some examples that show the range of costs in 1993-94.
Under the 4-year university plan, the lump-sum payment was $5,879
for an eleventh grader and $5,639 for a newborn; the monthly
payments were $328 and $47, respectively. Under the 5-year
installment plan, payments were $125 for an eighth grader and
$121 for a newborn.
Under the 2-year community college plan, the lump-sum payment was
$2,065 for an eleventh grader and $1,328 for a newborn; the
monthly payments were $115 and $11, respectively. The 5-year
installment plan payments were $41 for an eighth grader and $29
for a newborn.
Under the community college/university plan, the lump-sum payment
was $4,983 for an eleventh grader and $4,127 for a newborn; the
monthly payments were $278 and $35, respectively. The 5-year
installment plan payments were $103 for an eighth grader and $89
for a newborn.
For a 1-year dormitory contract, the lump-sum payment was $2,002
for an eighth grader and $1,589 for a newborn; the monthly
payments were $43 and $14, respectively; and the 5-year
installment plan payments were $43 and $35, respectively.
For a 4-year dormitory contract, the lump-sum payment was $7,755
for an eighth grader and $6,156 for a newborn; the monthly
payments were $166 and $51, respectively; and the 5-year
installment plan payments were $166 and $132, respectively.
The tuition prices quoted reflect an average 6.5-percent surcharge
over the 1993 tuition rates to ensure that the payments would meet
future tuition costs. The cost of prepaid dormitory contracts is
based on a weighted average of dormitory rates throughout the state
university system.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:3.4
The beneficiary can begin using benefits up to 3 years in advance of
the expected date of enrollment specified on the contract as long as
the contract is paid in full. Benefits can be used for up to 10
years after the anticipated date of enrollment. Also, the time frame
can be expanded an additional 10 years upon request, for an
additional fee. Any time spent on active duty in the U.S. armed
services will be added to the time frames for using tuition and
housing benefits. Also, students can attend part time, spreading out
their tuition credit hours over more than 4 years. In addition,
beneficiaries always qualify for resident status tuition, even if
they move out of Florida after the contract is purchased.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:3.5
Purchasers are allowed to change their benefit plan while still
making payments, in some cases even after the beneficiary starts
college. For example, if a student with a prepaid contract for the
4-year university plan decides to enroll in a community college
instead, the benefits will be used to pay the lower tuition rate, and
the purchaser will be given a refund of the difference, which can be
used to pay for other educational expenses.
Also, if a student with a prepaid contract for the community college
plan transfers to a state university after 1 year, the student's
remaining benefits will be applied toward tuition at the university.
The conversion calculations are based upon the tuition rates at the
time of enrollment. Any unmet costs will be the responsibility of
the student.
If the beneficiary gets a scholarship, the purchaser will get a
refund with interest for each semester covered by the scholarship.
Contracts may be used at any in-state private or out-of-state,
not-for-profit institution that confers baccalaureate degrees. If a
beneficiary attends a private in-state institution, the program will
pay the school the amount equal to the cost of public tuition at the
time of enrollment. If a beneficiary attends an out-of-state
institution, the program will pay the school an amount equaling the
value of Florida public tuition at time of enrollment or the original
purchase price plus 5 percent interest compounded annually, whichever
is less.
Purchasers may elect to terminate a contract at any time. If the
purchaser terminates a contract because a beneficiary dies or becomes
disabled prior to enrolling in college, the purchaser will get a
refund equal to the amount paid into the plan plus 5 percent
compounded interest or the current in-state tuition rate, whichever
is less.
When contracts are terminated for other reasons, refunds are
typically for the amount paid into the plan minus administrative
fees; no interest is refunded. For instance, if a beneficiary leaves
school (whether voluntarily or not) before completing all the
semester hours paid for in the contract, the purchaser will receive a
refund of the remaining benefits, minus an administrative fee of $50
or 50 percent of all money paid, whichever is less. However, this
refund will not include payments for the remainder of any semester in
which the student was enrolled. Also, if a contract for the 4-year
university plan is terminated after a student completes an Associate
of Arts degree, but the student decides not to pursue further
education, the $50 cancellation fee will not be assessed.
If a contract held 2 years or less is terminated because of default
or purchaser's decision to voluntarily cancel the contract, the
refund will equal the total of all money paid into the plan minus an
administrative fee of the lesser of $50 or 50 percent of all money
paid, and any outstanding late fees. For contracts held more than 2
years before termination by election or default, no administrative
fee is subtracted from the refund.
The purchaser can change the beneficiary named on a contract so long
as (1) the new beneficiary is a sibling, half-sibling, or
step-sibling of the original beneficiary; (2) the new beneficiary
meets the requirements of a designated beneficiary at the time of the
substitution; and (3) the substitution is made before the original
beneficiary enrolls in college. The purchaser must pay a $5 fee for
substituting beneficiaries. Additionally, if the new beneficiary is
expected to enroll in college more than 3 years before the original
beneficiary, the purchaser also must pay a sum to ensure the
actuarial soundness of the program.
The program can terminate a contract if the program finds that the
purchaser made fraudulent statements relating to the beneficiary's
residency. If this happens, the purchaser gets a refund of all
remaining money paid into the fund after charging a termination fee.
The program will charge either 100 percent of money paid into the
plan or $250, whichever is less.
ADDITIONAL FEATURES
------------------------------------------------------- Appendix I:3.6
Florida's program offers a life insurance plan, underwritten by North
American Life Assurance Company, that ensures purchasers that
contract payments will be completed in the event of their death. A
prepaid contract purchaser must be under age 65 to qualify for the
life insurance policy. To acquire coverage, contract purchasers fill
in a special section on the basic program application. The cost of
the annual insurance premium depends on the contract payment plan,
the benefits purchased, and the age of the purchaser. During the
1993-94 enrollment period, the annual premiums ranged from $10 for a
person under 35 purchasing a community college contract under the
5-year installment plan to $225 for a person aged 50 to 65 purchasing
a university contract plus 4 years of housing under the monthly
payment plan. The insurance and annual premium payments continue
until the purchaser either makes the final contract payment or turns
75, regardless of whether all contract payments have been made,
whichever comes first. If a purchaser is ever more than 30 days late
with an insurance premium, the insurance will end. Also, the
purchaser can cancel the insurance at any time.
MICHIGAN
--------------------------------------------------------- Appendix I:4
Michigan enacted the Michigan Education Trust program in 1986. The
program, which first sold contracts in the fall of 1988, provides for
the prepayment of undergraduate tuition and fees at any of Michigan's
15 public universities and 29 community colleges. Although contract
sales were halted after the 1990 enrollment period, the program still
invests the money it received and honors contracts it sold. The
program is administered by the state Treasury Department.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:4.1
Participants could choose from three benefit plans--full benefits,
limited benefits, and community college. The full benefits plan
guaranteed to cover in-state tuition and fees at any 4-year public
college or in-district tuition and fees at any 2-year public college.
The limited benefits plan guaranteed to cover tuition and fees only
at any public colleges whose tuition costs did not exceed 105 percent
of the weighted average tuition cost of Michigan's 4-year
institutions. Finally, the community college plan covered
in-district tuition and fees at any of Michigan's 29 community
colleges. Under the full and limited benefits plans, individuals
could purchase contracts for 1, 2, 3, or 4 years; under the community
college benefit plan, individuals could purchase contracts for 1 or 2
years.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:4.2
Michigan's program had a limited enrollment period during the fall.
At the time of enrollment, purchasers had to pay $85 in nonrefundable
application and processing fees and specify the beneficiary and a
refund recipient, in case the benefits were not used by the
beneficiary. At the time of purchase, the beneficiary had to be a
Michigan resident, and the purchaser had to be a U.S. resident.
Purchasers did not have to be related to the beneficiary.
The program allowed businesses, as well as individuals, to purchase
contracts. Only one person could be named as the contract purchaser.
However, a beneficiary could be named on more than one contract. For
example, a parent and grandparent could each buy a 2-year full
benefits plan contract for the same child.
In its first 2 years of operation, purchasers had to make lump sum
purchases for all contracts. In 1990, however, purchasers could use
one of three monthly payment options to purchase contracts. Monthly
payments could be spread over 4, 7, or 10 years from the purchase
date, depending on how soon the beneficiary was expected to enroll in
college. Purchasers could not use the monthly payment option if
beneficiaries were past a certain age or grade in school. In
addition, purchasers could only use monthly payment options when
purchasing full benefits or community college plans. Payments could
be made through payroll deductions, direct debit, electronic funds
transfer, or with personal checks.
During all 3 years that contracts were sold, purchasers could also
finance a lump-sum purchase through secured loans available from
Michigan savings and loan institutions. If borrowers defaulted on
these loans, the program would pay off the lending institution from
the value of the contract. The terms of the loans varied by
institution.\48 The fee for processing defaults on secured loans was
$50.
--------------------
\48 We spoke with officials at three of the institutions that made
these loans. We found that, in general, purchasers had up to 15
years to repay the loans, depending on the age of the child. The
loan rates ranged from about 8.75 percent to 12.5 percent.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:4.3
The cost of contracts depended on a number of factors, including the
beneficiary's age or grade in school, and the benefit plan and
payment option chosen. In 1990, under the full benefits plan, 4
years of tuition cost $15,496 for an eleventh or twelfth grade
student, which represented the current cost of tuition and fees for
the highest-priced public university in the state. Contract prices
decreased along with the beneficiary's age. For instance, the same
plan cost $9,296 for a child in kindergarten. Prices also varied by
the chosen payment option. For example, if a purchaser chose a
monthly payment plan to pay for 4 years of tuition and fees for a
second grader, payments would be $130 a month for 10 years, $164 a
month for 7 years, or $252 a month for 4 years.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:4.4
Beneficiaries must notify the program when they are ready to start
college. The program will then pay the tuition each year as the
student enrolls. If beneficiaries do not meet residency requirements
for a Michigan school at the time of enrollment, they are responsible
for paying the additional charges of the nonresident tuition rate.
Students can use their tuition benefits up to 9 years after they are
scheduled to begin college.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:4.5
Beneficiaries may voluntarily terminate their contracts and get a
refund for a variety of reasons. They may also transfer contracts
under certain circumstances. Furthermore, the program makes
allowances for purchasers who stop making payments or who default on
loans to use benefits they have paid for.
Refund amounts vary depending on the reason for terminating the
contract, but they will never be less than the contract amount paid
to the program. In most cases refunds are not available until the
beneficiary reaches college age. Under the full benefits plan,
refund rules are as follows:
If the beneficiary receives a full scholarship, the average tuition
cost of Michigan's 4-year public institutions will be paid to
the refund designee in four annual installments.
If the beneficiary decides to attend a private institution in
Michigan, the weighted average tuition cost of Michigan's 4-year
public institutions will be paid to the beneficiary's chosen
school, or the lowest tuition at Michigan 4-year public
institutions will be paid to the refund designee.
If the beneficiary decides to attend an out-of-state college, the
average tuition cost of Michigan's 4-year public institutions
will be paid to the beneficiary's chosen school in four annual
installments.
If the beneficiary does not plan to attend any higher education
institution, the program will pay to the refund designee the
lowest tuition of Michigan's 4-year public institutions, in four
annual installments.
If the beneficiary dies or becomes disabled, the program will pay
the refund designee a lump sum equal to the lowest tuition of
Michigan's 4-year public institutions.
If a refund request for any other reason is approved, the program
will pay the refund designee the lowest tuition of Michigan's
4-year public institutions, in four annual installments.
In all these cases, except when the beneficiary attends an in-state
private college or in cases of death or disability, refunds will be
reduced by a $200 termination fee.
Refunds may not be available in certain circumstances. The most
significant restriction is that beneficiaries may not terminate their
contracts for a refund after they have completed more than half the
credit hours necessary to receive a 4-year baccalaureate degree, even
if they have not used the contract benefits to pay for college.
However, this restriction does not apply to graduates of Michigan
community colleges who terminate their contracts before enrolling in
a 4-year state institution. Beneficiaries may also lose their right
to a refund if they state fraudulent information in their contracts
or do not use their benefits within the 9-year time period after the
expected date of college enrollment.
Beneficiaries who are 18 years or older may transfer their contracts
to another beneficiary in their immediate family or the purchaser's
immediate family. Contracts transferred to an older person, or one
in a higher grade than the original beneficiary, will require an
additional payment to the program. Contracts may also be transferred
if the beneficiary dies or becomes disabled, or if the beneficiary
receives a full tuition scholarship. However, benefits cannot be
transferred after more than half the benefits have been used toward a
4-year degree. The fee for transferring the contract to a new
beneficiary is $25.
If purchasers using a monthly payment option stop making payments,
they are not terminated from the program. Instead, they receive the
educational benefits they paid for. If they want to purchase
additional educational benefits in the future, they can do so at the
new cost. Similarly, if a purchaser defaults on a secured loan, he
or she still can get any educational benefits remaining after the
program pays the savings institution the outstanding loan amount.
OHIO
--------------------------------------------------------- Appendix I:5
In 1989, Ohio created the Ohio Tuition Trust Authority, a state
agency specifically established to operate the Prepaid Tuition
Program. The program began selling tuition credits at the end of
that year for undergraduate education at Ohio's 13 public
universities and 23 community colleges. The program is backed by the
full faith and credit of the state.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:5.1
Participants purchase tuition credits. Each credit is worth 1
percent of the weighted average cost of full-time tuition and fees
for 1 year at Ohio's public universities. Therefore, at a 4-year
institution, 100 credits would cover a student's tuition and fees for
1 year, and 400 credits would cover 4 years' worth. At a community
college, 100 tuition credits would cover 2 years' worth of tuition.
Students can attend full or part time.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:5.2
Purchasers may enroll throughout the year. They must purchase at
least one tuition credit and pay a nonrefundable $50 enrollment fee.
There are no residency, relationship, or age requirements for
purchasers, although those under age 18 must have the signature of a
legal guardian. Beneficiaries must be residents when their account
is established and must have a social security number. The program
allows only one purchaser per account, but other individuals may
contribute. Purchasers may start multiple accounts for multiple
beneficiaries. Likewise, beneficiaries may be named on more than one
account.
When an account is opened, the purchaser must specify (1) whether the
purchaser or the beneficiary will receive the refund if credits are
not used, (2) whether the purchaser's consent is required to
terminate the contract, and (3) whether the purchaser's consent is
required to transfer some or all credits to a new beneficiary.
The program allows purchasers to make payments by check at any time,
using coupons provided by the program. Purchasers can also make
payments through payroll deduction or automatic transfers from
checking or savings accounts. However, the program requires monthly
minimum payments of $25 per contract for transactions made through
payroll deduction or automatic transfers.
The program also has offered various purchase plans that allow
participants to meet different savings goals. For example, the
"Helping Hand Package" encourages people to save $50 per month over
many years; the "Semester Package" encourages people to save $180 per
month over 1 year to prepay one semester of tuition. However, none
of these packages requires people to adhere to the payment
schedule--all payments are optional. Purchasers receive semiannual
account statements to give them an update of their status.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:5.3
The program sets prices each August for the following year based on
the annual weighted average of tuition and fees at Ohio's 4-year
public institutions. In addition, the prices reflect a premium to
ensure that the payments meet future tuition and administrative
costs. In 1994-95, the weighted average tuition was $3,455, but the
program charged $3,750, or $37.50 per credit, based on this
adjustment. Thus, the lump-sum cost of 4 years of tuition was
$15,000.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:5.4
Beneficiaries may redeem tuition credits 2 years after purchase. If
beneficiaries are not state residents when they start college, they
may have to pay the difference between the resident and nonresident
tuition rates if they return to Ohio to attend college.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:5.5
Beneficiaries who attend a state institution with tuition lower than
the weighted average may need fewer than 100 credits per year for
tuition and can spread their credits to cover more than 4 years of
school. Beneficiaries who attend a state institution with tuition
higher than the weighted average may need more than 100 credits per
year for tuition.
The program allows credits to be used at nonparticipating
institutions. For instance, if a beneficiary goes to a private or
out-of-state school, the program will pay the school the weighted
average tuition of the Ohio public colleges and universities at the
time. The beneficiary would be expected to pay any remaining costs.
Unused benefits can be refunded or transferred. Only beneficiaries
may request a refund or transfer of credits when they reach college
age. Credits cannot be refunded until the beneficiary is 18 years
old and the credits are mature (on account for 2 years or more).
Further, funds cannot be withdrawn before the beneficiary reaches
college age, except in cases of death or permanent disability.
Following are some of the conditions in which refunds apply, and
their amounts.
If a beneficiary receives a merit-based scholarship, the program
will either (1) pay to the beneficiary, through the academic
institution, an amount equal to the value of his or her credits;
or (2) refund 99 percent of the current weighted average tuition
after the student graduates.
If a beneficiary dies or becomes disabled, the program will pay the
refund recipient the greater of the current weighted average
tuition or the purchase price.
If a beneficiary graduates before all the tuition credits are
redeemed, the credits can be used for graduate or professional
studies, or they can be refunded at 99 percent of weighted
average tuition.
If a beneficiary requests a refund--either because he or she does
not want to go to college or has started but wants to stop--the
program delays any refund for 1 year to allow the beneficiary to
reevaluate the decision. Then, if the beneficiary decides not
to attend or finish college, the program will pay the refund
recipient a maximum of 100 credits per year until all credits
are paid, minus a $25 termination fee per year. The value of
the credits refunded is equal to 99 percent of the current
weighted average tuition. If the beneficiary decides to start
or return to college, the program will stop the refunds, and the
remaining credits can be used.
In any of these cases in which a refund might apply, a beneficiary
may choose to transfer any unused credits to a new beneficiary. The
new beneficiary must be an Ohio resident and an immediate family
member. The program charges $25 for transferring credits to a new
beneficiary.
After a beneficiary reaches college age, if there are no more
payments into an account or credits redeemed for 10 years, the
program may terminate the contract and keep the funds. The program
also may terminate a contract if it finds that fraudulent information
has been reported about the purchaser or beneficiary.
The state also reserves the right to terminate the program,
cancelling contracts and providing refunds.
PENNSYLVANIA
--------------------------------------------------------- Appendix I:6
Since the fall of 1993, the Pennsylvania Tuition Account Program has
offered tuition credits for use at Pennsylvania's public colleges and
universities. Pennsylvania has 14 community colleges; 14
universities that compose the state system of higher education; and 4
state-related universities, which include Pennsylvania State, Temple,
Pittsburgh, and Lincoln. The state's Treasury Department administers
the program, which was enacted in April 1992.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:6.1
Participants in the Pennsylvania Tuition Account Program purchase
tuition credits that can be redeemed toward tuition and mandatory
fees of undergraduate study at public colleges and universities in
the state. At 4-year institutions, each tuition credit equals one
twenty-fourth of an academic year of tuition for full-time students.
Thus, if attending as a full-time student, beneficiaries would need
96 credits to cover 4 years of study. At community colleges, each
tuition credit equals 1 credit hour. Community colleges require 15
credit hours per semester; therefore, a full-time student would need
to have 60 credits for the 2 years of study required for an associate
degree.
Participants can also purchase even smaller amounts, known as tuition
units, for use at 4-year and 2-year institutions. Each tuition unit
equals one-twentieth of a tuition credit.
In addition, purchasers have the option of purchasing credits or
units for a specific institution, or for one of the three standard
tuition categories--community colleges, state system of higher
education, or state-related institutions. The standard tuition
category is the approximate average tuition for 1 year's tuition at
all the schools within a given tuition category. Purchasers who are
unsure of the specific school the beneficiary will attend, but
certain of the type of school they will attend, might choose this
option. Purchasers receive an annual account statement showing the
total number of tuition credits purchased.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:6.2
Either the purchaser or the designated beneficiary must be a state
resident when the purchaser applies to the program. Purchasers must
be at least 18 years old, and they may designate themselves as
beneficiary. They may also designate the beneficiary as "unnamed" if
the credits will be used as part of a scholarship program approved by
the program. In addition, any legal entity can also be a purchaser,
enabling clubs and other organizations to establish accounts for
either specified or unspecified beneficiaries. While joint ownership
of an agreement is not allowed, beneficiaries can be named on
multiple agreements. Also, someone other than the purchaser may
contribute toward the account.
When applying, purchasers must designate the beneficiary's
anticipated date of college enrollment. They must also purchase at
least one tuition unit. Purchasers pay a $65 nonrefundable
application fee when applying to the program. Program enrollment
takes place throughout the year, but new prices go into effect each
year on September 1.
Purchasers may choose one of several payment methods, including
personal check, direct transfer from their bank account, and payroll
deduction. The program will change the payment method at any time
for a $1 fee, upon written request of the purchaser. Purchasers may
make either one lump-sum payment or send in payments whenever they
want using coupons provided by the program.
Benefits may be purchased at either the resident or nonresident rate,
depending on the beneficiary's residency at the time of application
or the residency status anticipated at the time the beneficiary
enrolls in college.
PRICING STRUCTURE
------------------------------------------------------- Appendix I:6.3
The price of benefits varies by institution, tuition category, campus
location, residency, and course of study. For example, at
Pennsylvania State University, tuition credits for the main campus
and two other campuses are the same, but for all other branches
prices are slightly different. Similarly, at the University of
Pittsburgh main campus, tuition credits for studying engineering or
nursing cost more than credits for studying arts and science or
social work. Community colleges also have a tuition credit price for
students who are state residents but live outside of the district of
the community college that they will attend.
Prices are based on current tuition prices, plus a premium based
largely on tuition trends at specific schools over a 20-year period.
The premium for credits at schools where tuition has increased
dramatically in recent years is likely to be higher than for schools
where tuition increases have been more moderate. The premium is
intended to guarantee that the credits will be of sufficient value
when they are needed. Premiums are set by an actuarial firm.
Following are some specific prices that were in effect from September
1, 1994, to August 31, 1995:
For community colleges, the lowest price of a tuition credit was
$50 for an in-district resident at Westmoreland Area Community
College; the highest price was $215 for an out-of-state student
at Bucks County Community College. The standard tuition price
was $64 for residents, $121 for out-of-district students, and
$175 for out-of-state students. This translates to $960,
$1,815, and $2,625 per semester, respectively.
Tuition credit prices at all universities in the state system of
higher education were the same--$129 for residents and $328 for
nonresidents; this translates to $1,548 and $3,936 per semester,
respectively.
At state-related universities, the tuition credit price ranged from
$126 for state residents at Lincoln University to $670 for
nonresidents in the pharmacy program at Pittsburgh. The
standard tuition price per credit was $233 for residents and
$480 for nonresidents, translating to $2,796 and $5,760,
respectively, per semester.
In all cases, a tuition unit is one-twentieth the cost of a tuition
credit.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:6.4
Tuition credits (and units) must be 4 years old before they can be
used. Beneficiaries must begin using their benefits within 5 years
of their projected enrollment date specified on the application. The
program will extend the start date an additional 5 years, although in
such cases, the program may require an assessment fee to ensure that
the tuition account will meet the tuition costs at the time of use.
Time spent on active duty in the U.S. armed services does not count
toward the 5-year period for beginning to use tuition credits. All
credits must be redeemed within 10 years after the beneficiary first
enrolls in college. Time spent on active duty will be added to this
10-year period.
To use the credits, the purchaser or the beneficiary must write to
the program to request a certified statement of accumulated tuition
credits. The letter must include the name of the institution to be
attended, the amount of any scholarship awards, the number of the
account as it appears on the agreement, and the institution's tuition
rate.
Next, the program will convert credits if changes occur in the
selection of a specific institution or the category of institutions.
The conversion is an adjustment between what has been purchased and
what the credits will actually be used for. For instance, the
program will convert credits if a beneficiary changes from one
institution to another. Also, if payments were made for a standard
tuition category, the program will convert the credits once the
student selects a specific school. The conversion also takes place
for changes in residency. In these cases, the student may end up
with more than enough credits or not enough credits, depending on
what was originally purchased and how the credits were later used.
Beneficiaries who do not have enough credits will be expected to pay
any remaining costs. Beneficiaries with excess credits can apply
them toward a master's degree or some other postbaccalaureate
program. Also, if the student decides to attend college on a
part-time rather than full-time basis, the cost may be greater per
credit hour. In this case, the program will also convert the value
of the account to the part-time equivalent.
After the conversion is made, the program will send the certificate
to the purchaser or beneficiary. The purchaser or beneficiary must
then forward the certificate to the institution. The institution
will return the certificate to the program with a letter certifying
that the student has been accepted for that academic year.
The value of prepaid benefits does not affect eligibility for
state-based financial aid. If the beneficiary gets a scholarship at
either a participating or nonparticipating institution, a refund will
be given for the benefits covered by the award in the amount of
either the tuition for the number and type of the tuition credits
purchased or the value of the account, whichever is less. However,
such refunds for a given academic award will not exceed the amount of
the scholarship for that year.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:6.5
Tuition credits may be applied toward the cost of tuition at
nonparticipating institutions, which include private in-state or any
out-of-state schools meeting certain accreditation standards.
However, tuition credits are not guaranteed to cover the student's
tuition at a nonparticipating institution. Tuition credits may be
redeemed for a nonparticipating institution once the beneficiary or
purchaser submits to the program an invoice for tuition at the
institution. The program will then pay the institution the lesser of
(1) the amount of the invoice, (2) the actual tuition for the number
and type of credits purchased, or (3) the full value of the account,
which is all money paid for credits or units plus a pro rata share of
fund earnings. Any remaining costs must be paid by the student.
If the beneficiary decides not to go to college, the purchaser can
exercise one of two options--designate a substitute beneficiary or
request a refund. If a substitute beneficiary is chosen, the
substitute must be a family member of the purchaser or the original
beneficiary, and must meet residency requirements if the purchaser is
not a state resident. If the purchaser requests a refund, the
program pays the purchaser either 90 percent of the tuition for the
number and type of the tuition credits purchased or 90 percent of the
value of the account, whichever is less.
If the purchaser chooses to withdraw from the program for any other
reason, the purchaser receives the lesser of (1) 90 percent of the
tuition for the number and type of the tuition credits purchased, (2)
90 percent of the value of the account, or (3) all money paid toward
tuition credits or units.
If the beneficiary dies or becomes disabled, or if the beneficiary
fails to gain admittance into college, the program pays the purchaser
the value of the account. If the beneficiary fails to redeem all
credits within the appropriate time frames, the program will
terminate the agreement. In this case, the program will pay the
purchaser either 90 percent of the tuition for the number and type of
the tuition credits purchased or 90 percent of the value of the
account, whichever is less.
Purchasers may transfer agreement ownership to a new purchaser, as
long as the new purchaser is a family member of the current owner and
meets residency requirements if the beneficiary is not a state
resident. In addition, transfers must be made without consideration;
that is, benefits cannot be sold or traded.
WYOMING
--------------------------------------------------------- Appendix I:7
Under the Advanced Payment of Higher Education Costs Program,
contracts are sold for undergraduate education at the University of
Wyoming or any community college in the state. The program was
established in 1987, and contracts first went on sale that summer.
The program is administered under the auspices of the University of
Wyoming Board of Trustees.
EDUCATIONAL BENEFITS
------------------------------------------------------- Appendix I:7.1
The program allows people to prepay the costs of tuition and fees
only, or tuition, fees, and room and board. Purchasers can buy
contracts for 2 years at a community college, and 1 to 4 years at the
University. The program offers contracts for both residents and
nonresidents.
ENROLLMENT PROCESS
------------------------------------------------------- Appendix I:7.2
Contract purchasers need not be state residents, and they can
purchase multiple contracts. Enrollment takes place throughout the
year. However, each year the program establishes new prices that are
only in effect from August 1 through August 15. The program adds 10
percent annual interest to purchases after that date. No application
fee is charged.
PRICE STRUCTURE
------------------------------------------------------- Appendix I:7.3
Costs vary dramatically depending on which benefit package is chosen,
when the beneficiary will enroll, and the beneficiary's residency.
For example, as of August 1993, the least expensive benefit plan was
$3,763 for tuition and fees for 2 years of community college
beginning in 2013. For a resident enrolling in 2002 for 4 years at
the University, a contract covering tuition, fees, and room and board
was priced at $43,766. For a nonresident, that same contract would
have cost $122,847.
Purchasers may make lump-sum payments with cash; money orders; or
personal, cashier's, or registered checks. They may also finance
their purchase through a secured loan offered by various Wyoming
banks, savings and loans institutions, and credit unions.\49 If the
purchaser fails to make payments, the University reimburses the
unpaid amount to the lending institution. At that point, the
contract will be terminated and the program will refund the purchaser
any funds that remain after settling the default.
--------------------
\49 We spoke with a loan officer at one of the lending institutions
and found out that purchasers have 10 years to pay back the loan at a
fixed rate, including a 5-year balloon payment. As of January 1995,
that rate was 8 percent. If the purchaser has good credit at the end
of the first 5 years, the loan balance can be refinanced for the
remaining term at the existing loan rate.
REDEEMING PREPAID BENEFITS
------------------------------------------------------- Appendix I:7.4
Beneficiaries have 6 years from the anticipated college enrollment
date to use the benefits. The beneficiary's residency status at the
time of admission is determined by the school, regardless of the
status when applying to the program. Beneficiaries who have
contracts for in-state tuition but are deemed nonresidents by their
school must pay for the additional costs. Likewise, beneficiaries
who qualify for in-state tuition but have nonresident contracts can
use the additional funds for other educational expenses.
PROGRAM FLEXIBILITY
------------------------------------------------------- Appendix I:7.5
Purchasers can cancel their contract and receive a refund if the
beneficiary dies, attends a nonparticipating institution, is not
admitted to college after properly applying, decides not to attend
college, or elects not to use the benefits and a substitute
beneficiary is not named.
The amount of the refund depends on whether benefits have been used
yet. If the purchaser cancels the contract before any benefits have
been used, the program will refund the advance payment plus 4 percent
interest compounded annually. If the purchaser cancels the contract
after some benefits have been used, the program will refund the
advance payment plus 4 percent interest compounded annually, minus
any benefits used.
A substitute beneficiary may be named at any time to take advantage
of any unused benefits.
ADDITIONAL PROBLEMS STATES MAY
ENCOUNTER IN ESTABLISHING AND
OPERATING A TUITION PREPAYMENT
PROGRAM
========================================================== Appendix II
In addition to unresolved federal tax questions (discussed in ch.
4), officials identified a variety of other problems or barriers that
states may face in setting up and running a tuition prepayment
program. Three of the problems they emphasized most included (1)
developing actuarial assumptions that accurately reflect trends in
college costs and investment returns, (2) encountering opposition
from various public and private interests, and (3) working out the
administrative details involved in daily program operation.
Knowledge of these problems, and how they have been dealt with, may
be instructive to state officials who are interested in starting such
a program in the future.
MAKING ACCURATE ACTUARIAL
ASSUMPTIONS
-------------------------------------------------------- Appendix II:1
One problem that some officials identified has to do with the
accuracy of key actuarial assumptions: problems can arise for these
programs when tuition rates increase faster than expected or
investments earn a lower return than expected. Two officials
described how the years preceding the start of their programs turned
out not to be a good predictor of tuition and interest rates in the
years after the programs began. The economic landscape changed, one
official explained; state revenues decreased, which led to pressures
to increase tuition rates faster than anticipated, and at the same
time interest rates declined. Rising tuition rates seemed
particularly vexing to two officials we interviewed. How can state
universities justify an 11-percent tuition increase, one asked
rhetorically, in a year when the general inflation rate is 3 percent?
Two officials who described being somewhat disappointed with the rate
of return they have received on their investments said they may begin
to invest more aggressively in equities. Unexpectedly large tuition
increases, however, have not proven an easy problem for officials to
deal with. One director described raising the prices for program
benefits, but said that the program may now be too expensive for many
people to afford. Another official said it would be easier to
operate the program if the state had some central control over
colleges' tuition rates.
ENCOUNTERING OPPOSITION FROM
VARIOUS SOURCES
-------------------------------------------------------- Appendix II:2
Another barrier some officials described is opposition from a variety
of sources, particularly when the program is initially under
consideration, but also during its operation. For example, state
politicians can raise concerns about the potential for the program to
create an unfunded liability for the state; public higher education
officials may worry that the program will lead to a cap on tuition
prices or a reduction in their funding, making it harder for colleges
to cover their expenses; private college representatives may raise
the issue of student choice and the possibility of declining
enrollments at their institutions; and members of the banking and
investment industry may argue that a state program allowing families
to prepay the cost of college will take away business from the
private sector.
The ability of program proponents to overcome this type of opposition
is obviously important to their ultimate success. Following are some
examples of the strategies program officials have used.
To deal with the potential opposition from public colleges, one
official described having several meetings with college
representatives early in the developmental stage to explain how
the program would work and correct any misperceptions they might
have had about the program's implications. College officials
were also invited to participate in drafting the authorizing
legislation. Giving top officials from the state's higher
education system a seat on the board overseeing the prepayment
program can also help ease their fears, some officials reported.
To deal with opposition from banks, insurance companies, and other
private sector firms, one program director has described the
importance of emphasizing the noncompetitive aspects of tuition
prepayment programs. "For example, advertising should stress
the guarantee of payment of future tuition, rather than any
perceived rate of return on the premiums paid."\50 Another step
programs can take is to give the private sector some of the
business, by contracting out for services such as sales,
marketing, and records administration.
--------------------
\50 William Montjoy, "State Prepaid Tuition Plans: Designing a
Successful Program," Prepaid College Tuition Plans: Promise and
Problems, ed. Michael A. Olivas (New York: College Entrance
Examination Board, 1993), p. 47.
RESOLVING ADMINISTRATIVE
DETAILS
-------------------------------------------------------- Appendix II:3
An additional challenge for some states has been working out the
administrative details of implementing and operating the programs.
Numerous decisions must be made, such as what part of the operation,
if any, should be contracted out versus handled in-house. Officials
must develop the program rules; consult with attorneys, actuaries,
and investment advisors; and hire staff with the skills needed to
operate the program. Records administration posed a particularly
difficult challenge for two programs: officials described having to
develop customized computer systems to keep track of purchasers'
accounts because there were no adequate systems commercially
available.
In resolving these kinds of problems, officials in different states
have made different decisions. For example, officials in Ohio
decided to run the tuition prepayment program entirely in-house with
about 17 full-time staff members. In contrast, Florida has only
eight full-time staff and contracts out for almost all its services.
Officials in two states mentioned that in setting up and running
their programs, they have benefitted from the expertise of staff in
the state treasury department. Finally, a few officials mentioned
the value of talking with their colleagues in other states where
these programs were already in place and learning from their
experiences.
FEDERAL TAXATION A MAJOR ISSUE
FACING STATE TUITION PREPAYMENT
PROGRAMS
========================================================= Appendix III
The most serious issue facing state tuition prepayment programs is
the potential applicability of federal tax provisions. Two potential
taxes are particularly troubling to program officials: (1) a tax on
program investment earnings, because that would make it more
difficult for programs to meet their future liabilities, and (2) an
annual tax on participants, because that would be unappealing to
purchasers and an administrative burden, according to program
officials. Uncertainty about federal taxes began with Michigan's
pioneering program and persists to this day. Moreover, because of
the negative impact such taxes can have on these programs, some
states have decided to delay program implementation and others have
backed away from the concept altogether. Favorable resolution of
these issues would help existing programs to succeed and stimulate
renewed interest in these programs among other states.
MICHIGAN'S HISTORY OF TAX
PROBLEMS
----------------------------------------------------- Appendix III:0.1
Federal taxation has been an important issue since Michigan
established the first state tuition prepayment program, the Michigan
Education Trust (MET). The statute creating MET required that before
the program could sell any contracts, it had to obtain a ruling from
IRS that purchasers would not be subject to federal income taxes on
the benefits they purchased or on the program's investment earnings.
MET requested a private letter ruling\51 in February 1987. IRS ruled
in March 1988 that (1) purchasers may be liable for the federal gift
tax, (2) beneficiaries would be required to pay federal income taxes
on the increased value of their benefits at the time of redemption,
and (3) MET itself would have to pay federal taxes on its investment
earnings.
On the third point, MET had argued in its ruling request that its
investment earnings were exempt from federal taxation primarily
because it was an "integral part of the state" and traditionally the
federal government does not tax the direct income of states.\52 In
its ruling, however, IRS concluded that MET was not an integral part
of the state, essentially because (1) it was created as a corporation
to operate independently from the state, under an appointed board of
directors whose decisions could not be overridden by the state, and
(2) its funds did not come from the state or one of its political
subdivisions, were not available to state creditors, and could not be
used by the state for any purpose.\53
Although some observers saw the ruling as unfavorable--because of the
requirement that MET pay taxes on its investment earnings--the ruling
satisfied Michigan's statutory requirements, and the program began
selling prepaid tuition contracts in the fall of 1988. In compliance
with the letter ruling, MET paid $15.8 million in corporate taxes for
its first 3 years of operation. In 1991, however, lower investment
returns made it more difficult to stay ahead of tuition inflation
while also paying the required federal taxes. Therefore, MET
suspended new contract sales and requested a full tax refund. When
IRS denied the refund request, MET and the state of Michigan sued the
United States, arguing that the program's investment earnings were
exempt from federal taxes because it was an integral part of the
state or, if not on that basis, then for other reasons.\54
MET lost the case in U.S. district court in July 1992 but won its
appeal in the Sixth Circuit Court of Appeals in November 1994. The
Circuit Court concluded that MET is an integral part, as well as a
political subdivision, of the state and therefore tax exempt; IRS was
ordered to refund all corporate taxes MET had paid over the years
(now totaling more than $60 million), with interest. IRS, concerned
that the decision was too broadly reasoned and could have significant
administrative implications for its operations, requested a rehearing
of the case in the Circuit Court, but was denied. Subsequently, the
Solicitor General decided not to appeal the Circuit Court's decision
to the U.S. Supreme Court.
--------------------
\51 As explained in an IRS publication, "A `letter ruling' is a
written statement issued to a taxpayer" by the national office of IRS
"that interprets and applies the tax laws to the taxpayer's specific
set of facts." See Revenue Procedure 95-1, Department of the
Treasury, IRS, Publication 1375 (Rev. 1-95),
p. 7.
\52 Alternatively, MET argued, its investment earnings could be
excluded from gross income under section 115 of the Internal Revenue
Code, which provides that gross income does not include income
derived from the exercise of any essential government function and
accruing to a state or any political subdivision thereof.
\53 The ruling also concluded that even if MET were a political
subdivision of the state, it still would not have qualified for an
exemption under section 115 because its income mainly served the
private interests of particular individuals, rather than the public
interest of the community in general. Priv. Ltr. Rul. 88-25-027
(Mar. 29, 1988).
\54 Michigan and MET also argued that the program's investment
earnings were exempt from federal taxation under (1) section 115 of
the Internal Revenue Code, as discussed earlier; (2) sections
501(c)(3) and (c)(4) of the Code, pertaining to tax exempt
organizations; (3) the doctrine of intergovernmental tax immunity;
(4) the tenth amendment of the U.S. Constitution, which reserves to
the states powers not prohibited to them nor delegated to the federal
government; and (5) the Guarantee Clause of the Constitution, which
guarantees to every state a republican form of government.
TAX ON INVESTMENT EARNINGS A
MAJOR CONCERN FOR PREPAYMENT
PROGRAMS
----------------------------------------------------- Appendix III:0.2
IRS's ruling on MET, along with the subsequent district court
decision, heightened the concerns of officials in other states about
whether and how tuition prepayment programs would be taxed. For
these programs to survive and proliferate, one official said, it is
critical that their investment earnings not be subject to federal
taxation. In response to this concern, some states have delayed
plans to implement tuition prepayment programs; others decided
against implementation, choosing instead to issue college savings
bonds as an alternative way to help families save for college; and
some states implemented their programs, although trying in various
ways to avoid some of the problems Michigan encountered.
SOME STATES DEFER ACTION
BECAUSE OF CONCERNS ABOUT
TAXATION
--------------------------------------------------- Appendix III:0.2.1
IRS's decision to tax MET's investment earnings was troubling news to
states interested in tuition prepayment programs. Paying such taxes
makes it more difficult to meet future liabilities without setting
benefit prices prohibitively high. After the MET ruling, several
states that had been interested in starting tuition prepayment
programs backed away from the idea, discouraged by the prospect of
getting a similar ruling. Among these states, according to various
written accounts, were Maine, Missouri, Oklahoma, Tennessee, and West
Virginia. In Virginia, 1994 legislation authorizing a tuition
prepayment program stipulated that the program cannot begin selling
contracts until IRS rules that the program's investment earnings are
exempt from federal taxation.
Indiana also indefinitely postponed implementation of a tuition
prepayment program, after receiving its own letter ruling from IRS in
September 1988. Although it was much less publicized, the ruling was
similar to Michigan's, concluding that Indiana's proposed program
would be subject to federal taxes on its investment earnings. Given
the corporate tax rate the program would have faced, earning
investment returns sufficient to cover future liabilities would have
been difficult, according to one Indiana official. "We didn't feel
that we could keep up with tuition costs that are rising about 9
percent a year. We would have to earn a return of around 13 percent
before taxes to get 9 percent after taxes."\55
--------------------
\55 Cited in Jacqueline Mitchell, "Michigan Flunks Its Tuition Trust
Fund," Wall Street Journal (Mar. 26, 1992), p. C16.
OFFICIALS FOCUS ON MAKING
PROGRAMS INTEGRAL PART OF
STATE
--------------------------------------------------- Appendix III:0.2.2
In light of Michigan's experience, other states that have started
tuition prepayment programs have tried to structure them more clearly
as an integral part of the state. Alabama and Pennsylvania, for
example, tried to make a stronger link between the program and the
state by placing the program within and under the direct control of
the treasury department. Alaska and Wyoming established their
programs within the state's higher education system. Alaska's
program Director reasoned that since the University of Alaska, which
offers the program, is exempt from federal taxes as an
instrumentality of the state, this exemption should apply to the
tuition prepayment program.
Another step states can take to help protect their programs'
investment earnings from federal taxation is to back the program with
the full faith and credit of the state. Thus far, IRS has emphasized
this as a significant factor toward gaining recognition as an
integral part of the state, because it clearly demonstrates the
state's financial stake in the program. However, Florida's program
is the only one to operate with the full faith and credit of the
state from its inception. By statute, in the event of a shortfall
the legislature must appropriate to the program sufficient funds to
enable it to meet its obligations to qualified beneficiaries.
Some states have not backed their tuition prepayment programs with
the full faith and credit of the state, officials told us, because
their state constitutions prohibit them from extending such a
financial guarantee. That did not stop Ohio, however. In 1994, to
better position the program as an integral part of the state, the
legislature put on the ballot a measure that proposed amending the
state constitution to back the tuition prepayment program with the
state's full faith and credit. In the November election, state
citizens approved the measure overwhelmingly.
Ohio officials also saw other advantages in this strategy. First, it
allowed them to reduce the price of their benefits. Prior to
approval of the ballot measure, Ohio had charged a premium on its
tuition credits, so that in case IRS ruled that the program owed
taxes on its investment earnings, it could pay the taxes without
endangering the fund's actuarial soundness. The premium added
significantly to benefit prices, which made them less appealing to
purchasers and was also a factor in prompting the governor to
question the program's value to purchasers, as described briefly in
chapter 2. Second, Ohio officials believe that having the program
backed by the state's full faith and credit will appeal to
purchasers, making its guarantee seem more reliable.
POSSIBLE SHIFT FROM DEFERRED
TO ANNUAL TAX ON
PARTICIPANTS ALSO A MAJOR
CONCERN
----------------------------------------------------- Appendix III:0.3
Although a private letter ruling pertains only to the taxpayer who
requests it, program officials in other states have generally
interpreted IRS's ruling on the tax consequences for MET purchasers
and beneficiaries as applicable to their programs, too. Thus,
program materials alert purchasers to the potential gift-tax
liability, and each year program officials notify all beneficiaries
using their benefits of the increased value of those benefits for
federal income tax purposes. Although some program officials would
ultimately prefer that both of these taxes be eliminated, they are
generally not considered a hindrance to successful program operation.
For example, although purchasers have to file gift tax forms, few
will ever have to pay this tax, because a unified estate and gift tax
credit of $192,800 can be used to shield them from gift tax
liability. In addition, requiring students to pay taxes when they
use their prepaid benefits does not create a disincentive for people
to join these programs, two directors explained, because the
potential tax burden on beneficiaries is likely to be small, given
that students typically have very modest incomes and, therefore, are
subject to low marginal tax rates.
Recently, however, program officials have become very concerned that
IRS may change its opinion on the federal tax liability of program
participants. IRS has indicated that regulations proposed by
Treasury on contingent debt could be interpreted as applying to the
transaction involved in state tuition prepayment programs; that is,
the prepayment agreement would be considered a debt instrument. This
interpretation could result in the owner of the benefits--either the
purchaser or the beneficiary, depending on specific program
details--being liable for federal income taxes annually on the
imputed interest on his or her investment in the program. Thus, if a
participant spent $1,000 on prepaid tuition benefits and the
applicable interest rate was 5 percent that year, the participant
could owe federal income taxes on $50.
Taxing participants this way would have a serious negative impact on
program operations, according to several officials. First, they
believe purchasers would not understand or be receptive to paying
taxes on income they had not personally received, sometimes referred
to as "phantom income." This tax requirement would make these
programs seem more complex and much less attractive to potential
purchasers, officials claim, which could decrease program sales
significantly. Second, they claim that having to notify participants
of their potential tax liability every year would impose an
administrative burden on program operations. Some program officials
recently expressed these views in letters to IRS and in testimony
before IRS and Treasury officials on the proposed regulations.
SOME PROGRAMS AWAITING IRS
RULINGS
----------------------------------------------------- Appendix III:0.4
In addition to MET, other state tuition prepayment programs have also
sought IRS guidance on federal tax issues, but definitive answers to
their questions have been delayed by the MET case and other factors.
Like MET, four other programs we studied--those in Alaska, Florida,
Ohio, and Pennsylvania--also took the precaution of requesting a
private letter ruling from IRS to get clarification of the relevant
federal tax issues.\56 But none of these four programs has received a
ruling; Florida and Ohio have been waiting 5 years.
IRS officials told us they did not expect to issue rulings on any
other tuition prepayment programs as long as the MET case was in
litigation. But even though the Solicitor General recently decided
not to appeal the MET case to the Supreme Court, rulings on other
programs may not be immediately forthcoming for a variety of reasons.
For example, IRS may wait until Treasury issues the final regulations
on contingent debt, expected late this summer, because, as described
earlier, they could have implications for how IRS would rule on the
federal taxes applicable to program participants. In addition, IRS
could decide to audit a state tuition prepayment program that it
believes is liable for federal taxes on its investment earnings. If
ordered to pay these taxes, the program might then challenge IRS in
court, arguing--like MET did--that its investment earnings are tax
exempt because the program is an integral part of the state.\57 While
litigation was ongoing, other ruling requests could remain
unanswered.
In general, IRS officials explained, state tuition prepayment
programs raise issues of national significance with potentially
far-reaching implications. For example, if states can implement
prepayment programs for higher education expenses, perhaps they will
try to start similar programs for the advance payment of other goods
and services. These considerations require IRS to be very careful
and circumspect in its analysis and ruling, officials said, which
takes time.
--------------------
\56 Officials in Wyoming did not request rulings because they felt
confident their program was designed in a way that would make its
investment earnings tax exempt. On the advice of legal counsel,
Alabama officials did not request an IRS ruling for similar reasons;
however, the Director said they may decide to do so in the future.
\57 IRS's goal would be to have its position supported in a different
Circuit Court of Appeals than the one where the MET case was decided,
because once there is conflict between circuits, the chances are
greater that the Supreme Court will become involved.
GAO CONTACTS AND STAFF
ACKNOWLEDGMENTS
========================================================== Appendix IV
GAO CONTACTS
Wayne B. Upshaw, Assistant Director, (202) 512-7006
Timothy W. Silva, Evaluator-in-Charge, (202) 512-7041
ACKNOWLEDGMENTS
In addition to the individuals listed above, the following staff
members contributed significantly to this report: Tamara A. Lumpkin
was responsible for the analysis of income data and helped write the
report, Bob DeRoy and Paula J. Bonin did the computer programming,
Regg Hatcher helped analyze program participation levels, and Julian
Klazkin assisted with legal matters.
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