Private Prepaid Tuition Programs Can Help Make College Affordable

Ask any parent about his No. 1 financial concern and you likely will hear, "Paying for my children's college education."  Rising tuition threatens to drive the cost of college beyond the reach of many lower- and middle-income families. 

But help is on the way.  A little-known provision signed into law by President Bush as part of the Economic Growth and Tax Relief Act of 2001 will make affording college a bit easier for many families.  Specifically, part of the new tax law eliminates all federal income taxation on qualified tuition savings and prepaid tuition programs and clears the way for private colleges and universities to offer prepaid tuition plans to interested parents and students.  While receiving little attention and constituting a relatively small part of the overall law, this provision represents a tremendous step toward making college more affordable for more parents. 

The idea of offering parents the option to prepay higher education costs—often years before their children are ready for college—started in Michigan in 1986 when the state Legislature authorized the Michigan Education Trust (MET).  Since the launch of MET, more than 20 other states have established prepaid tuition programs.  The state programs come with their own problems and sometimes become political footballs that politicians kick around.  But they received a boost in 1997 when Congress passed a law deferring taxes on all the interest they earn.

However, it was not until President Bush affixed his signature to the recent tax bill that private colleges could offer similar plans with similar tax advantages.  Many private colleges and universities in states with strong public pre-paid plans were in jeopardy of losing future students due to this unequal playing field.

Already, a consortium of over 275 private colleges from across the country—including, in Michigan, Albion College, Hope College, Kalamazoo College and Lawrence Technological University—has formed to offer prepaid tuition redeemable at the member institutions.  In fact, this group of colleges has one-upped the state-operated prepaid plans by offering parents, grandparents, and other relatives the option of prepaying tuition for their loved ones at a discount from today's tuition rates.

Tax-free prepaid tuition plans are solid public policy.  They encourage savings, which leads to greater economic growth.  Over time, they can reduce dependence on government aid.  A private college's pre-commitment to honoring discounted tuition will help check the overall cost of higher education.  And, as any parent will attest, eliminating concern over tuition inflation is welcome any time.

Prepaid tuition plans make sense for other reasons. With only minor clarifications in existing law, it is quite possible that a corporation, charitable organization, or alumni club interested in establishing a scholarship program could purchase prepaid tuition certificates.  These certificates, when mature, could be given to promising students.  One can imagine Ford or General Motors purchasing prepaid tuition as an additional employee benefit or incentive, or DaimlerChrysler supporting an ongoing scholarship program for low-income families by purchasing tuition to Michigan colleges for years in advance.

Most importantly, the emergence of prepaid tuition programs for public and private colleges is a big step toward a more genuine free market in higher education and a better-informed buying public.  Under a more market-oriented system, ratings that investors use to evaluate mutual funds, stocks, and bonds could be adapted to "rate" the education and experience offered by various colleges.  Coupled with an active market in prepaid certificates, such a ratings system would allow parents to more fully evaluate the return on investment they and their children can expect from particular institutions.  Should that return not meet their expectations, they would have the option to trade their certificate for tuition at another institution of their liking. 

It will take years for many of the benefits associated with prepaid tuition to emerge.  However, the immediate availability of the prepaid tuition option for both public and private institutions should be comforting to parents wrestling with one of their most difficult financial challenges. 

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(John S. Barry is director of research at the Tax Foundation in Washington, D.C. and an adjunct scholar with the Mackinac Center for Public Policy.  Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.)