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With Prepaid College Fund, State Hopes to Help Parents Save

By Annie Gowen
Washington Post Staff Writer
Thursday, January 8, 1998; Page M01

When Joe DeFeo's second child was born in 1993, he started losing sleep over rising college tuition costs, worrying about whether the mutual fund he'd set up for both his children -- now ages 6 and 4 -- would be enough to pay for their college education.

"You hear about the huge amount of money you'll need, and you think, `There has got to be another way,' " said DeFeo, 38, a television news director from Columbia.

At a time when public school tuition has far outpaced regular inflation rates, rising about 8 percent yearly over the decade, Maryland state officials have developed a new education savings program to help quell parents' fears about the rising costs of college tuition.

The Maryland Prepaid College Trust fund, which begins operating this month, will allow parents to lock in the price of state college tuition at today's rates and pay for it either in a lump sum or in installments.

"It is increasingly very, very difficult for working families to be able to send their children to college," said Gov. Parris N. Glendening. "We're trying to do everything possible to make it easier for them."

The fund, created by the Maryland state legislature last year, is overseen by a board of directors that includes the state comptroller, the state treasurer and the secretary of higher education and four other members appointed by the governor. The state is hiring outside banking, accounting, actuarial and marketing firms to manage the fund, and all its investments will be approved by the board.

During a limited three-month open enrollment period beginning this month, investors can sign up for one of three tuition plans: a two-year education at a Maryland public community college, a four-year degree at a state institution of higher education or a "two-plus-two" plan for two years at a community college and two years at a four-year university. The contract does not guarantee a child's admission, and only Maryland children -- newborns to ninth-graders -- can be enrolled.

Each plan will require parents to contribute on a set fee schedule, based on the child's age, payment and college option chosen. Buyers can choose lump-sum, monthly or five-year payment plans and must pay an application fee, tentatively set at $75.

The plan's administrators are marketing the plan with a variety of local radio and television ads and are aiming for middle-income families who do not have a savings program in place. Those families, they feel, may like the idea of having a fixed monthly college tuition payment, similar to a car or rental payment.

"This program is designed for the smaller saver who doesn't want to manage money in a portfolio. It's a fixed payment structure," said Edwin S. Crawford, the fund board chairman and acting executive director. "People want ease and simplicity. They don't want to be bothered by mutual funds."

Maryland becomes the 19th state offering a prepaid college tuition plan. Twenty-one other states plan to offer consumers state tuition savings plans in the next year, according to Barbara M. Jennings, executive director of the College Savings Plan Network, an association of savings plan groups that is an offshoot of the National Association of State Treasurers.

The genesis of state-run tuition savings plans dates to the 1980s, when tuition costs spiraled. "Middle-income families were getting priced out of the market," Jennings said. "Now, these types of programs guarantee that they can keep up with tuition inflation. Parents and grandparents really respond to that."

Tuition savings money is tax-deferred until used, then taxed at the student's tax rate.

While such a tax break could be a boon for higher-income investors, some financial planners question whether participation in such plans is wise, given the higher rate of returns from other investments.

Tom Grzymala, a financial planner and the president of Alexandria Financial Associates in Alexandria, analyzed the Virginia Prepaid Education Program, launched last year. He estimated that investors must make only a 6 to 6.5 percent return on their money to equal the rate of the return for the Virginia plan. The "rate of return" for prepaid plans is estimated as the percentage of tuition increase.

In Maryland, according to one state study, tuition at state secondary schools rose 8.3 percent annually from 1986 to 1996. Assuming it will continue to rise at about the same rate, investors would need to make more than that to better the prepaid tuition plan.

But given that the S&P 500 historically returns 10 percent, stocks and mutual funds are still a wiser choice, Grzymala said.

"A prepaid tuition plan is a good idea for people who need a disciplined savings tool," he said. "Otherwise, one can do better elsewhere."

Others, like DeFeo, worry about getting locked into a contract he may regret 20 years down the road, when his children are getting ready to make plans for college. "It's a gamble," he said.

But the plan's administrators say that the plan is flexible enough to accommodate the vagaries of a student's college choice later in life. Your child wins a scholarship? Or your child decides to go to a private or out-of-state school? The fund will return the unneeded money, with accrued interest, less "reasonable administration fees."

Things get stickier if you decide to withdraw the money because your child decides not to attend college or you want to cancel the contract altogether. Then you may lose one-half of your earnings on the money, plus administrative costs. The plan can be transferred to siblings with no penalties.

The trust has received more than 2,000 calls from residents seeking information. Crawford said that the trust expects to sell 10,000 to 12,000 contracts during the first enrollment period, expected to start this month and run through April. Virginia's plan had 16,000 enrollees during its first enrollment period, with contracts totaling $250 million.

For more information about the Maryland Prepaid College Trust, call 1-888-4MD GRAD or write 217 E. Redwood St., Suite 2050, Baltimore, Md. 21202.

The trust fund's Web site can be reached at www.prepaid.usmd.edu

© Copyright 1998 The Washington Post Company

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