It’s official. The State of Alabama officially reneged on its promise to college-bound students this week when the judge approved a class-action lawsuit settlement that allowed the state to forever ‘freeze’ future tuition payments based on 2010 tuition fees.
One Birmingham News reader, Susan, wrote me in disgust saying that she purchased the five-year payment contract for her one-year-old granddaughter thinking she had made a wise financial move by guaranteeing an in-state four year college education. Now she’s not certain what she should do. Should she continue the program or cash in her money in favor of another education strategy?
Hmmm, that’s a really good question for all PACT contract owners and the correct answer is… ‘It depends’. Least you accuse me of sounding like one of our state legislators, allow me to give you a brief review of the new rules of engagement:
- What you get if you stay in– Payment of future tuition and fees will be frozen based on the fall 2010 tuition and fee rates for our in-state institutions. This means that you bear the risks of rising tuition and fees. Historically, tuition rises about 8% per year which means costs double every nine years. The PACT Board, at their full discretion, can choose to raise payments beyond the 2010 guarantees.
- What you get if you quit– If you decide to quit, you’ll receive your ‘redemption value’ which is essentially a return of what you’ve invested in the program. Any gains you theoretically earned will be forfeited.
I had one of my associates play with some numbers to develop a general rule-of-thumb and he decided that if you’ve been invested in the program for longer than the number of years until the child will begin taking money from the program, you’re better off staying in the program. Otherwise, cash in your chips. For a more precise mathematical calculation, follow these steps:
- Determine your Redemption Value (how much you’ve paid into the PACT plan).
- Determine the ‘Estimated Total Contract Value’ from the PACT website (www.treasury.state.al.us/PACT/). For example, four years at Alabama or Auburn is estimated to be $35,550 (potentially frozen forever).
- Determine the rate of return you’d have to earn on your money between now and when the child enters college as compared to the Estimated Total Contract Value.
- If you feel you could easily earn that rate of return or higher by investing in, say, the Alabama 529 plan, then there’s your choice. If you think it’s unlikely that you could earn that rate of return, stick with the PACT plan.
For example, one of my associates invested $8,630 in a 4-year Pact in 2001 when his son was age two. Assuming his son attended the University of Alabama, he’d have to earn approximately 26% to equal the guarantees offered under the PACT plan. He’ll stay put.
Another associate invested $6,800 in a 1-year PACT for his newborn in 2009. The PACT guarantee is only about $8,800. He’d only have to earn 2% to beat the PACT guarantee. He’ll take his money and invest in the 529 plan.
In our reader’s case, I would recommend that Susan retrieve her money from PACT and reinvest it in the Alabama 529 plan (www.collegecounts529.com) using one of the Vanguard mutual funds. Under this strategy, she’ll receive a state income tax deduction for her annual contributions of up to $10,000; the money will grow tax deferred; and when used for qualified education expenses, withdrawals will be tax free. Consult your financial advisor before acting on this advice.
Regardless of your decision, you’ll want to calculate the total costs of paying for college so you can develop an appropriate strategy. For the ‘simplest college calculator in the world’, visit the Resource Center at www.WelchGroup.com; click on ‘Links’; then click on ‘College Funding Calculator’.
To comment on this article or to have your financial questions answered, email me at email@example.com.
Correction: Birmingham News reader Jim McKittrick correctly pointed out that our government is spending 64% more than they are collecting in revenue each year rather than the 10% I had indicated in last week’s column. Whew! That’s a big hole we’re digging!