After an initial surge of enthusiasm, state interest in college-prepayment plans has waned in the past two years as a result of concerns over federal taxes and future costs, a new survey by the Education Commission of the States indicates.
Eleven states have enacted plans for “tuition futures” or prepayment programs, in which parents or other benefactors can pay a sum that will cover future tuition for their children at state postsecondary institutions.
But several of these states have had second thoughts about implementing the programs because of concerns about U.S. Internal Revenue Service rulings that the benefits could be subject to tax.
Instead, states are increasingly turning to savings-bond programs to help parents cover the rising cost of higher education, the survey found.
“College-savings plans have con4tinued to grow in popularity because they don’t pose the same problems as tuition-prepayment plans,” said Christine Paulson, who conducted the survey along with Aims McGuinness Jr.
College-bond programs have been adopted in 19 states, 12 of which had conducted bond sales as of September.
The Michigan Model
The first tuition-prepayment plan was adopted by Michigan in 1986. That program has served as a model for other states, with differences over such issues as refund policies.
In 1988, the irs ruled that investors in the Michigan Education Trust would not be liable for taxes for earnings on their money used to pay tuition. But the fund itself would be liable for trust taxes, the agency declared, and students would have to pay taxes on the earnings of their contract in the year it was redeemed.
This and similar individual rul8ings by the irs have been a major factor cited by other states for not proceeding with prepayment plans.
Some states also worry that they would be liable if the prepayment plan’s investments did not yield enough income to cover tuition costs.
“The impetus to adopt these programs has diminished,” Ms. Paulson said.
Even so, several states have said their tuition-prepayment programs are proceeding successfully.
“We’ve had great success with the Michigan Education Trust program here,” said Robert Kolt, spokesman for the state treasury. “It really takes the worry out of tuition costs. Every time a college increases its tuition, we get calls to our hotline.”
Some 82,000 people applied for the program in its first year, with more than 40,000 enrolling. Last month, 15,000 residents applied for its second year.
Mr. Kolt said the decline in applicants was expected because in the first year of the program, there was a tremendous “pent-up demand.”
The tax-liability question does not appear to be a concern to parents enrolling in the program, he added.
In addition, Alabama and Ohio passed enabling legislation for tuition-prepayment plans this year, and Louisiana is considering such a plan.
Alabama officials believe that they can establish a program that will avoid some of the uncertainties of other states’ programs.
“There are things you can do to ensure the soundness of the trust and to avoid tax consequences,” said Brenda Emfinger, executive director of the state’s Pre-Paid Affordable College Tuition program.
The Alabama program will be open only to students currently in the 8th grade and below.
But many more states have decided to go the savings-bond route in the past two years, the survey notes.
Tennessee, for example, set up a prepayment program in 1987, but changed to savings bonds this year.
“We felt there was strong question as to whether there would be liability leveled against the state if the fund did not earn the money necessary to cover the inflationary cost of tuition,” said Ron Gambill, executive director of the Tennessee Student Assistance Corporation.
Copies of the “1989 Survey of College Savings and Guaranteed Tuition Programs” are available for $5 each from the ecs, 1860 Lincoln St., Suite 300, Denver, Colo. 80295.