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Tapping into TAP New changes in state's tuition aid program boost attractiveness Monday, August 21, 2000 By Frank Reeves, Post-Gazette Staff Writer
A new law goes into effect today designed to make Pennsylvania's Tuition Account Program more attractive to families saving for their children's college education.
But the most significant change to TAP, the creation of a new savings program that works much like a mutual fund, won't be in operation until next year.
Established in 1993, TAP has come under increasing criticism from those who argue that families would have done better to put their money in a mutual fund that has an aggressive investment strategy rather than in TAP, whose goal is simply to keep pace with increases in college tuition. It essentially has acted as a prepaid tuition plan, allowing families to purchase college and university tuition at today's prices for future use.
The only problem is, college tuition costs have risen about 5 percent annually during the past 10 years, while the stock market has done much better -- rising in the double-digits annually. "That is why most [investment] advisers recommend you put your money in a mutual fund and not look at [TAP]," said Neil Alexander, a vice president at Hefren-Tillotson Inc., a Downtown money management and financial planning concern. "You could do better in an aggressive mutual fund."
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Until now, the way TAP has operated has been fairly straightforward: Families could pre-purchase college tuition credits today for future use, with a guarantee that the credits would cover the full cost of tuition at a state university regardless of how much tuition costs rose. The credits were pegged to tuition costs at the state's publicly funded schools, but could be used to defray costs at accredited public and private schools anywhere in the country. In the case of private schools and out-of-state public universities, TAP didn't guarantee that the pre-purchased credits would cover full tuition costs.
Among TAP's most attractive features have been tax breaks that were created when Congress, responding to public fears over soaring tuition costs, authorized the states to establish college tuition savings programs. First, the account owner pays no federal taxes on his or her TAP account while it is accruing in value; it is only when money in the account is used that it is subject to federal income taxes, and only the increases in value -- not the principal -- are taxable. Second, because the student who is the beneficiary of the account is responsible for the tax, and not the parents, the tax rate typically is lower. Last, TAP is exempt from Pennsylvania state and local income taxes.
Since 1993, more than 30,000 Pennsylvania residents have invested in the prepaid tuition account program. About 1,500 students are now using the credits to pay tuition at 288 colleges and universities, according to the Office of the State Treasurer, which administers the TAP program.
When lawmakers debated the desirability of establishing TAP, there was concern that the program's investments wouldn't provide enough money to keep up with rises in college tuition.
But a bullish stock market has increased TAP's earnings far in excess of tuition inflation. The program has developed large surpluses, more than it needs to stay solvent and cover its guarantees.
Others have complained about the rigidity of the program, noting that the TAP credits could only be used for tuition and not for other expenses such as books, lab fees, room and board.
Last June, the state lawmakers approved legislation aimed at addressing those concerns and enhancing the program.
For example, TAP's prepaid tuition plan was revamped and is now described as a "guaranteed savings plan." Like the original TAP, it guarantees tuition credits purchased today against higher prices in the future, and either the account owner or the beneficiary must still be a Pennsylvania resident. But now any surplus not needed to keep the program solvent will be distributed to account owners in the form of additional tuition credits.
TAP accounts already can be used at any college, private or public. But previously, the state's guarantee to keep up with tuition inflation applied only to in-state public institutions, such as the University of Pittsburgh, Penn State and 14 state-owned universities. Now residents can buy credits, and get the same guarantee, at individual private colleges that choose to participate in the program or receive credits based on the average tuition level at Ivy League schools or the state's four-year private colleges. Account owners also would be able to use credits not only for tuition but for lab fees, books, room and board.
Perhaps most significantly, the so-called TAP Enhancement Law also created a college savings plan, based on market investments, that works much like a mutual fund.
Congress all along has permitted the establishment of these market-based savings plans, and they have proved to be increasingly popular. Twenty-eight states currently offer them in some form, according to Joseph Hurley, an accountant and author of a book on ways to save for college. Pennsylvania next year will become the 29th state when its TAP savings plan kicks in.
What distinguishes this mutual fund-like investment program from the prepaid tuition program is the underlying investment strategy. Prepaid tuition plans, such as the original TAP, were often touted as "a safe and affordable" way for families to save for a college education. The mutual-fund-type savings plan is geared for families who want to pursue a more aggressive, and therefore riskier, investment strategy.
The savings plans are run by an independent money manager selected by the state, and are tailored to the age of the beneficiary child. For instance, the investment strategy for families with young children would be more aggressive than the strategy for families with children on the threshold of college. State Treasurer Barbara Hafer's office is just beginning the process of selecting an outside firm to manage the revamped TAP program.
Hurley said the newly enacted changes in TAP "are certainly an improvement, a real giant step." But he acknowledged that the so-called 529 plans, named for the section of the Internal Revenue Service code that covers them, may not appeal to everyone. "Some active investors with more money to move around may not have the patience to give control over their money to a state program."
Hefren-Tillotson's Alexander said many factors should be weighed when deciding whether to opt for a 529 plan, including the parents' taxable income and tax bracket, and the student's eligibility for financial aid. For example, moderate income families may find it to be more beneficial to rely on financial aid in the future, as opposed to participating in the state's tuition savings plans.
There are several resources families can use when weighing whether to TAP or not. The Pennsylvania Tuition Account Program Web site is a good first stop: www.patap.org. TAP also has a toll-free phone number, 1-800-440-4000, and has produced a brochure entitled "Important Facts to Consider When Joining TAP."
Hurley's book, "The Best Way to Save for College: a guide to section 529 plans," is available through his Web site, www.savingforcollege. com. The book includes a list of things to consider before joining a 529 plan, as well as comparisons with other investment strategies for saving for a child's college education. It also compares various section 529 plans currently in effect.
Finally, there's TIAA-CREF (Teachers Insurance and Annuity Association College Retirement Equities Fund), an investment manager for several state tuition savings plans. Its Web site, www.tiaa-cref.org, contains information on various tuition savings plans as well as information on other investment options, including federal savings bonds and education-oriented Individual Retirement Accounts.
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