By Gary Brooks, CFP®
If you have been near a television or radio for any length of time over the past few weeks, you’ve probably heard advertisements for the Washington Guaranteed Education Tuition (GET) program. The annual ad blitz coincides with the May 31 enrollment deadline for new GET accounts. Existing GET participants can buy units to add to their account at this year’s unit price up until June 25.
Whether or not to open a GET account – or keep funding one – requires an ongoing review of the pros and cons compared to other college savings options.
The basic operation of the program requires participants to pay a set price for each unit to be used in the future. As many as 500 units can be purchased. It is expected that 100 units covers a full year of tuition at a Washington four-year state university (although you can use the account at any U.S. college). While GET offers a guarantee to keep up with the cost of state-school tuition, you pay a significant premium over today’s tuition in order to receive that guarantee. The premium is so steep that if your child is older than 10, and possibly even 8, it probably doesn’t make sense to buy GET units.
For the past three academic years, the payout value of a GET unit has been $117.82. The purchase price is $172. That’s a 46% premium over the payout value. To catch up to what you pay for each unit, you need the payout value to rise. But with state tuition having been frozen the past couple years, people who paid $172 per unit in the 2012-13 enrollment period still have not made any step toward breaking even on the premium they paid for the GET guarantee.
This premium over the current payout value has increased significantly over the years. In 2001-02, the payout value was $38.98 and the new unit purchase price was $42, a 7.7% premium. From 2008-09 to 2011-12, the premium exploded from 13% over payout value to 59% as the state needed to increase the buy-in cost to accommodate for the combination of large investment losses and climbing tuition costs.
If you purchase GET units this year and tuition increases at 5% annually (assumedly increasing the GET payout value by the same 5%) it would take eight years before the payout value exceeded the $172 per unit that you paid.
If tuition rises at 6% per year, the $172 breakeven would be reached in the seventh year. At 7% tuition growth, the breakeven is in the sixth year. But what if tuition increases have reached a plateau or much slower growth rate than they exhibited through the 1990s and 2000s? At just 3% tuition growth going forward, the $172 payout value wouldn’t be reached for 13 years.
Imagine that you purchase a GET unit for $172 in your child’s first year and you hold onto it for 20 years using it to fund a small portion of their junior year tuition. If today’s payout value grows at an average annual rate of only 3%, after 20 years it would reach $212.80, a 23.7% cumulative return (1.19% annualized) on your initial $172 investment. If the payout value/tuition rises 5% per year, the cumulative return over 20 years would be 81.8% (4.1% annualized).
That’s a better return that might approach the territory of being worth paying a significant premium to earn the guarantee. So, if your child is very young and you expect that tuition costs will rise by 5% or more per year between now and when they begin to use GET units, it might be a worthwhile investment.
GET is a prepaid tuition program where the Washington State Investment Board takes the investment risk to keep the program funded. There is another variety of Section 529 college savings plan where growth on the account is tax free if used for qualified higher education expenses. With these plans, you make contributions and choose the investment strategy, hoping that the investments will outpace the growth of college costs. There is no guarantee that the account value will keep up with college costs. But you also don’t have to pay a significant premium over today’s cost in order to participant.
Consider if you took the same $172 that you could use to purchase a single GET unit today and instead opened a 529 account (most have higher initial enrollment minimums). If your investment averaged a 5% annual return for the same 20 years as the example above, you would achieve a 165% cumulative return on your initial investment, ending value of $456.37.
It may seem like a traditional 529 savings plan has an edge over GET but now you need to weigh the likelihood that you would actually achieve the 5% average annual return (or better). Many people in these accounts used age-based investment choices that start out aggressively positioned while the child is young and become conservative with mostly bonds and cash as the college date approaches. They may generate better than 5% returns in the early years but experience limited returns in the later years.
You don’t have to invest in an age-based portfolio. You could choose a moderate, or even aggressive, mix of stocks and bonds and hold it throughout the life of the account. Taking this investment risk could very well work out but it introduces wider variance in the potential outcomes.
You should also consider that we appear to be approaching the end of a 30+-year bull market in bonds that could roll over into a stretch of low future bond returns. Stocks also appear to be trading at a premium which could reduce their future returns below the historic assumption of 8-10% per year on average.
Possibly, a layering of both GET units and a 529 account, is the most optimal way to approach college savings. GET has a maximum of 500 units meant to align with tuition. Of course there are other costs of going to college so you’ll need to fund them beyond a GET account, especially if a private college is preferred.
But don’t expect GET to generate much actual return on your investment. And if you’re getting a late start in college savings, don’t bother with the GET program.
GET – THE EARLY YEARS
For early participants, the GET program has been a terrific investment. Participants who bought units in 2001-02, for example, paid $4,200 per 100 units which are now worth $11,782, nearly a 13% average annual return.
GET PARTICIPANTS BEST CASE, WORST CASE
If you’ve purchased GET units over the past five years, or expect to do so in the near future, you would like to see a return of tuition inflation that coincides with an increase in the payout value of the GET unit. Ideally, you can at least get back to even with the purchase price. It will have been expensive insurance against tuition inflation – insurance that came with a large opportunity cost for having not invested elsewhere at better returns over the past few years — but at least you get your money back.
The worst case for the program involves a combination of weaker investment returns, climbing tuition costs and lower enrollment. While the program is solvent currently – due to strong investment returns, flat tuition and rising costs per new unit – the reverse of those factors could cause trouble. The weaker the investment return and higher the cost of tuition, the more new enrollees at a higher entry price will be required to keep the program funded. If enrollment declines because it appears to be too expensive, it will hurt. This combination of factors is why some other states have closed their prepaid tuition programs.
Two more points worth noting:
1) If you contribute to a 529 account through an advisor who charges a commission, your likelihood of achieving 5+% returns is diminished by the size of the commission. There are several direct sold plans with low costs and adequate investments.
2) If you purchase GET units, do it in lump sums. Ongoing payment plans include a 7.5% service charge that diminishes the likelihood the account will ever be worth more than the purchase price.
|Washington Guaranteed Education Tuition (GET) details|
|Enrollment Year||Unit Price||Payout value||Premium||Tuition increase|
In May 2014, I appeared on a panel for KBTC’s Northwest Now with GET director Betty Lochner. The video of that interview is available here.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma.