Virginia's college savings program will sap taxpayers

I can see your future.

No, I’m not a former employee of the Psychic Friends Network, nor do I have a palm-reading business on Williamson Road. I don’t even need a crystal ball to make this prediction: A taxpayer bailout of Virginia’s college savings program is in your future.

That’ll be $50, please. Cash only.

How can I tell your future? Because this week, the board of the Virginia College Savings Plan voted to reopen enrollment into its prepaid tuition plan (VPEP) starting in early October.

According to my reading of the tea leaves, they should have kept the program closed.

The reason is that the program makes a promise to parents (of any income level) saving for college that the state will make up the shortfall if parents don’t save enough. And that promise is backed up with your checkbook.

I’ll give you a little background on the college savings plan. The prepaid tuition plan allows Virginians to pay for a child's future education today and lock in tuition rates to Virginia’s four-year public colleges and community colleges. Parents can make payments over time or with a single payment. The state guarantees to cover the child’s future tuition bill to any public college in Virginia, regardless of how much tuition rates may increase between now and then.

The state then invests the savings plan money, hoping to grow those investments at least as fast as tuition rates increase over the years. If the investment grows faster than tuition inflation, the state gets to keep the extra revenue. But if tuition grows at a faster rate because investment returns falter (as has happened in 2000-2002), or the General Assembly decreases funding for higher education and that causes schools to increase tuition (as they have done the last several years), taxpayers will have to make up the difference.

Taxpayers already subsidize every in-state student’s tuition at public colleges as it is.

These college savings plans are popular with parents who worry that fast-rising tuition rates could make college education too costly by the time their child reaches college age. Locking in today's tuition cost years before your child enrolls, and putting the risk of rising costs on the public, seems like a good deal.

For the last 25 years, tuition and fees at colleges nationwide have increased at an average annual rate of six to eight percent, which is two to three times faster than the rate of inflation. The investment return the state will need to get on the prepaid tuition fund will at least have to match that.

But poor investment returns and the continuing rise in tuition have strained college savings programs. Many states with these plans have had to decide whether or not to bail them out with taxpayer funds, withdraw tuition promises, raise plan payments, or limit future enrollment.

The board of the Virginia College Savings Plan had closed the VPEP program from 2003-2004 because of a long delay in the adoption of a state budget, which made it difficult to predict how much state college tuitions would rise, and also because of the slump in investment markets over the last several years.

Virginia's solution this week was to reopen its plan and raise prices 30-60 percent over what they were when the program closed to new enrollees in May 2003. For example, a four-year college plan for a newborn will cost $32,772 -- compared to $20,464 during the 2003 enrollment period.

But even with that increase, as well as sharp increases in previous years, analysts have predicted that lower investment performance and higher tuition increases and expenses could produce a $260 million shortfall in Virginia’s prepaid college fund by 2018.

That’s a shortfall taxpayers will likely have to shoulder.

The big question is: What right does the commonwealth have guaranteeing parents a 6 to 8 percent (or higher) return on their investment at the public’s expense? Will they guarantee that type of return on my 401(k), too? It’s been looking pretty shabby lately.

The bigger problem is that no one can predict investment performance or the rate of tuition inflation, so the financial liability caused by this guarantee could be totally open-ended, with no cap, potentially costing the taxpayers much more than $260 million predicted (just look recently at the poor job state officials did with predictions of budget deficits and surpluses).

What’s the solution?

Virginia needs to learn what the business world learned years ago. Corporate America started getting away from “guaranteeing” their employees retirement pensions several years ago, and they started letting employees handle their own retirement investments through 401(k) plans. Employees now decide how much to put away and what to invest it in. Companies did this to rid themselves of the tremendous financial liability of guaranteeing benefits 20-40 years down the road, when they had absolutely no way of predicting how much those benefits would cost them.

Virginia should immediately reverse this week’s decision and keep its prepaid guaranteed plan closed to all new investors and phase out the program after the last investor graduates from college.

People who want to save for college can use two other more viable investment plans that the Virginia College Savings Plan offers: VEST and CollegeAmerica. The main difference is that these plans don’t have a taxpayer-backed tuition guarantee, so their returns are based on the performance of high quality mutual funds and other vehicles that invest in the stock and bond markets. In most cases, these investments are tax-deferred as they grow AND the withdrawals are tax-free if you use them for college expenses. With those tax advantages, it really makes the money stretch a lot further (so even lower income people can save a tidy egg for college).

If college savers don’t like the risk of being in the markets, they can invest their college money in savings bonds instead, where their investments won’t lose value.

However, even after I warn you about all this, my crystal ball predicts that you won’t push your legislators to do anything about it. We’ll end up 20 years from now with lots of promised money to send kids to college, and no real money to do it. It will be just like the Social Security insolvency issue. And just like with Social Security, you’ll look back and say, “Those idiots predicted 20 years ago that this wasn’t going to work, and now my grandson’s college fund is worthless. Where’s my guarantee now?”