How to think about prepaid tuition plans: Washington’s Guaranteed Education Tuition plan

I’ve written extensively about 529 college savings plans, which are a way for the wealthy to permanently shield intergenerational transfers of appreciated assets from taxation while also allowing those assets to internally compound tax-free. However, there’s a second kind of investment vehicle conceived of by section 529 of the Internal Revenue Code: prepaid tuition plans.

While every state, the District of Columbia, and Puerto Rico all offer 529 college savings plans, only a few states took section 529 seriously and endeavored to set up prepaid tuition plans.

Washington State’s Guaranteed Education Tuition (GET) plan

Washington’s GET plan has a simple structure:

• At any time, you can buy any number of “units” at a purchase price determined by GET’s actuaries each year, until the total number of units purchased per beneficiary has reached 600.
• When the beneficiary enrolls in a qualified educational institution, you can request disbursement of up to 150 units per year at a unit payout value equal to 1% of the tuition and mandatory fees charged by the most expensive public university in Washington state.

A few things to note here:

• In any given year, the unit purchase price will be higher than the unit payout value. This year, the unit purchase price is $113, while the unit payout value is $103.86. That’s because they’re not selling this year’s tuition and fees, they’re selling tuition and fees at an unknown point in the future.
• 600 units is equal to 6 years of tuition and fees at the most expensive Washington public university, but you can redeem up to 150 units per year, so if you bought 600 units, you could be reimbursed for 150% of that amount against the tuition and fees at a more expensive four-year college (like all 529 plans, you can only request tax-free distributions for qualified expenses).

To give an extreme example, you could purchase 600 units today for $67,800. You would break even when tuition and fees in Washington rose to $11,300 per year, about 8.8% higher than they are today. As tuition and fees rose still further, you’d experience the same tax-free appreciation of your investment seen in 529 college savings plans, except instead of depending on stock or bond market performance, your returns would depend on the trajectory of Washington state education funding.

This is, needless to say, a curious investment. It combines a credit risk (will Washington state honor the terms of the program in 10, 20, or 50 years?), an inflation hedge (the “purchasing power” of your investment is protected from tuition increases as long as you attend a Washington public college or university), and a speculative bet (Washington state tuition inflation will outpace the performance of your public market investments).

What happens if tuition and fees go down?

I’m glad you asked, since that very thing happened in 2015!

In that year, the Washington legislature passed the “College Affordability Plan” which reduced tuition and fees from $11,782 to $11,245, and then to $10,171. By rights, this should have reduced the unit payout value of accounts from $117.82 to $101.71, a decrease of 13.7%.

But it didn’t. By special dispensation from the state legislature, GET was allowed to maintain the higher unit payout value, and then when they finally reset the unit payout value to match the new, lower tuition and fees, they compensated account holders by increasing the number of units in their accounts by a corresponding amount!

Look: I’m not a Washington state taxpayer. I don’t own and am not the beneficiary of a GET account. But this kind of “heads-I-win-tails-I-win” policymaking is a textbook example of moral hazard. If GET investors participate fully in the upside of tuition inflation and are protected from the downside of tuition deflation they’re going to be the beneficiaries of huge wealth transfers from their fellow citizens of Washington state, and the country as a whole.

Should you invest in a prepaid tuition plan?

A few years back I learned about the story of Bert Fingerhut, who, as a wealthy and successful Wall Street investment banker, criss-crossed the country opening accounts in his own name and the names of anybody else he could think of at so-called “mutual savings banks,” so that if they ever reorganized as publicly traded entities he would be entitled to pre-IPO shares. What he was doing was perfectly legal, he just wasn’t satisfied with only claiming shares for himself, so he fraudulently opened accounts of which he was the beneficial owner.

When researching the Washington state GET plan, I was reminded of poor old Bert, whose only crime was that he got greedy. I think if I were a sufficiently wealthy Washington resident, with a sufficiently young child, I’d buy my 600 GET units, not because such an investment is guaranteed to outperform the public markets, but because it’s an investment different enough from the public markets that it’s likely to perform differently from the low-cost stocks and bonds in a 529 college savings account like the ones offered by Vanguard and others.

After all, the most you can lose in a $67,800 investment is $67,800. If tuition and fees at the most expensive Washington public universities rises at the same rate as median hourly wages, the maximum rate currently allowed by law, then based on data between 1990 and 2016, you’d expect your investment to return an average of 2.9% per year. If that cap is lifted and tuition and fees rise faster, you’d do even better, and if tuition and fees are cut again, there’s precedent for being made whole by the state legislature.

And all these returns are, of course, completely tax-free.