529 Savings Plans Contribute to College Credit Stability
The ability of colleges and universities to pass along costs to students is a major reason for the general credit stability of the sector. For most private and public institutions, the biggest source of revenue is tuition, and state-sponsored college savings plans--also known as 529 plans--are helping to keep revenue streams flowing.
"Higher education is a consumer product, and institutions need students who can pay full price for the product," says Standard & Poor's Managing Director Mary Peloquin-Dodd. "If students can't afford to pay full tuition, institutions have to offer more tuition discounting and financial aid, which in turn takes away from other areas such as maintaining competitiveness, meeting increased labor costs, and providing for insurance, facilities management, and operations."
The growth of 529 plans, which are approaching their 10th anniversary this year, has been phenomenal as costs have dropped and investment options have improved. The Investment Company Institute, which periodically reports plan statistics, found that assets held in the plans grew by about 31 percent in 2006, to $90.1 billion from $68.7 billion at the end of 2005. The number of accounts rose to 7.2 million, and the average 529 savings plan account size was approximately $12,500. Earnings on the plans are exempt from federal income tax and generally from state income tax as well. In many states, contributions are tax-advantaged.
Looking at college from a supply and demand perspective, 529 savings plans help with both sides of the equation. On the demand side, people make decisions about college based on what they can afford. "From a credit perspective, we are concerned that with the cost of higher education getting so high, people might not be able afford higher education and make other decisions as to whether they will pursue higher education and where they pursue it," says Peloquin-Dodd. "What 529 plans do is provide a tax-deferred method of savings that can increase the number of schools that a student could afford. On the supply side, higher education institutions are seeing their costs rising as well, and they need a pool of students who can pay for their product."
Tuition has been increasing at public universities at a much higher rate than price increases for most other consumer products. During the past three years, some public universities adopted greater use of differential pricing, mid-year tuition increases, and increases of 25 percent or more in an academic year. While increases were lower on a percentage basis for private colleges and universities, the higher base meant a sizable increase in nominal student charges.
"Public universities are in a good position right now because state funding is growing," says Peloquin-Dodd. "However, the reality is that favorable periods of state funding don't last forever. On the other hand, federal funding for public universities is at a standstill, with research funding increasing by only 2 percent to 3 percent going forward." Peloquin-Dodd also notes that the federal government seems to be moving to a cost-sharing model with higher education institutions.
For a private college or university with a sticker price of $38,200 (all costs included) for the 2006-2007 academic year, a 5 percent price increase in student charges can mean a year-to-year increase of $1,900. "Colleges and universities are not unaware of the possible financial burden that tuition and fee increases put on their students," says Peloquin-Dodd. "Many schools are attempting to keep their financial aid packages in line with tuition increases by reserving a certain percentage of their increased revenues from tuition hikes for increased financial aid packages."
The stated amount of tuition at a college or university, especially a private one, is often not the amount actually paid. Tuition discounting is a common practice, and many colleges would lose students if they didn't discount. Keeping stated prices high, however, is often related to perceived prestige--the higher the tuition and fees, the better the school must be. Thus, it appears to be better for an institution, from a competitive position, to keep tuition and student charges high and discount when necessary to feed the applicant pool. Many prestigious private institutions feel that if their tuition is significantly below that of their competitors, then potential students and their families may perceive it as a lesser option.
"The difficulty that higher education institutions face is that tuition discounting peaked in the early 2000s, before U.S. job losses, at the height of the economic cycle," says Peloquin-Dodd. "Higher education now faces a double-edged sword because needier students and the rising costs of running higher education businesses means there simply is no flexibility to increase the amount of tuition discount. That means 529 plans will be playing a bigger role in meeting revenue goals going forward."
Although 529 plans are viewed as a credit positive for the higher education sector, whether these plans will continue to grow and what will happen if investment markets weaken remain open questions. The plans are likely to remain popular as long as they continue to have tax advantages.
"Let's face it," says Peloquin-Dodd. "Demand for higher education is heavily influenced by the ability for people to pay. To keep enrollment numbers up, institutions would otherwise have to offer financial aid to students," she added. "529 plans are helping to close the gap of college affordability."
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