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The Washington State 529 Program (GET) Offers an Overlay

Important update:

This was my take on things back in 2007, when it was published.  As of 2010, both my opinion and the math have sharply changed.  I revisit the issue in a new post.

State-administered “529 plans” for education savings are another in the series of tax dodges doled out by the Bush administration (thereby further and regressively lowering the effective rate of taxation on the higher-income people most likely to avail themselves of such dodges). (Sticklers will observe that 529s predate Bush; true, but their extra tax favorability is a post-2001 invention.) On the bright side, they offer quite a good deal if you can find an investment that keeps pace with college tuition (and you don’t need to worry about also beating the tax rake, since 529 gains are tax free when used for qualifying tuition etc.). You do have to nominate a beneficiary when you set one up, but you as the controlling owner can change the nominee at any time to any blood relation (and it can even be yourself).

There are two types of 529 plans: one is like a 401k plan and involves picking a retail investment or mix of assets; I’m sure someone, somewhere has done the analysis to pick out correlates of tuition costs, so if you can find that, maybe you should look at the first form. The second 529 plan is somewhat more interesting. In the second form, the 529 plan is actually selling you “prepaid tuition.” This kind of thing is normally a terrible deal: fronting money for something way in the future is generally a sucker bet, one made against the collected wisdom of armies of actuaries by not-sophisticated-enough retail investors with both informational and scale disadvantages. But I have a few reasons for believing that the Washington State 529 plan (known as the GET: see their web site) offers an overlay in certain circumstances.

1. Each state may offer either or both types of 529 plans to its residents. As it happens, a couple of states that have offered guaranteed tuition programs have run into trouble with the plans being underfunded and unable to meet obligations, according to this article. Although this might raise an alarm in some folks’ minds, to me it says that tuition costs have been rising faster than can be achieved by even the professional money managers hired by state 529 plans specifically to meet that hurdle rate. Therefore, I see it as a sign that tuition is in general an expensive thing to guarantee and that if you can get a reliable guarantee (see below), you are getting the best of it (until or unless a mean reversion on tuition growth rates vs. inflation occurs).

2. Washington’s GET program is (ostensibly) backed by the full faith and credit of the State, unlike other states’ 529 guarantees. In my mind, combined with the evidence of other states’ underfunding difficulties, that means the WA GET is a good bet to get bailed out by the State at some point in the future. (In general, any time you see something other than a plain vanilla bond backed by the full faith and credit of an American government, someone in the government got snookered or corrupted, and the public purse is about to make its counterparties rich: see e.g. the PBGC, the S&Ls, the Federal Housing Enterprises, etc.)

3. The index for the GET tuition price is the most expensive state university in Washington, invariably the University of Washington, located in Seattle, a thriving and growing metropolis which is well positioned to weather many economic threats and therefore in which prices and incomes are likely to remain high enough to induce the University to charge steadily increasing sums for tuition. (Although I certainly don’t think that the outlook for Seattle is monotonically ever rosier, it seems a much better bet than somewhere like e.g. Montana or Idaho, where relatively small disturbances to nondiversified industrial bases could result in stagnation at all state universities.) The University also has competition in town from a number of private schools charging full freight to their students, therefore establishing the viability of increased tuition at UW.

5. The WA GET program has a scam built into its marketing strategy: rich people can buy the tuition units at the “buy-in price” (see below), but they try to sign up poor people for a payment plan where they charge them 7.5% interest on top of the buy-in price. Whether this is morally appropriate or not is a separate issue; the fact that we can spot the fish (and we ain’t it) is good for us.

6. The big catch to the WA GET is the difference between the buy-in price and the pay-out value (the bid-ask spread, if you will). For the past few years, that has looked like so:

Year Purchase $ Purchase YOY % Purchase CAGR
1999 $35.00 NA NA
2000 $38.00 8.57% 8.57%
2001 $41.00 7.89% 8.23%
2002 $42.00 2.44% 6.27%
2003 $52.00 23.81% 10.40%
2004 $57.00 9.62% 10.25%
2005 $61.00 7.02% 9.70%
2006 $66.00 8.20% 9.48%
2007 $70.00 6.06% 9.05%
Year Payout $ Payout YOY % Payout CAGR
1999 $33.75 NA NA
2000 $35.19 4.27% 4.27%
2001 $36.42 3.50% 3.88%
2002 $38.64 6.10% 4.61%
2003 $45.31 17.26% 7.64%
2004 $48.63 7.33% 7.58%
2005 $51.81 6.54% 7.40%
2006 $55.05 6.25% 7.24%
2007 $58.80 6.81% 7.19%
Year Purchase $ Payout $ Payout Ratio
1999 $35.00 $33.75 96.43%
2000 $38.00 $35.19 92.61%
2001 $41.00 $36.42 88.83%
2002 $42.00 $38.64 92.00%
2003 $52.00 $45.31 87.13%
2
004
$57.00 $48.63 85.32%
2005 $61.00 $51.81 84.93%
2006 $66.00 $55.05 83.41%
2007 $70.00 $58.80 84.00%

Observations on these numbers:

  • 2003 saw a big bump in tuition and hence in both purchase price and payout values. This jibes with 2002 news reports of the same.
  • The payout ratio (payout $ / purchase $) has been declining steadily, but has recently hovered around 84%.
  • That said, WA GET is raising the price of purchase by 9% annually, while tuition has been increasing at 6-7% annually. If these two don’t converge, the payout ratio will get worse.
  • This supports a 6-7% tuition increase rate, especially because that makes the 7.5% interest on the payment plans accretive to GET’s situation.

7. The time-lag spread between purchase and payout makes sense only if you assume that college costs rise faster than the rate of return you can make elsewhere, adjusted for tax treatment. Assuming a fairly conservative 5.25% risk free rate and a 28% tax rate, the line crosses with 7% annual rising educational costs after about 6 years:

Years Held After-tax return risk free GET Return GET to risk-free %
0 $70.00 $58.88 84.11%
1 $72.65 $63.00 86.72%
2 $75.43 $67.41 89.37%
3 $78.36 $72.13 92.05%
4 $81.45 $77.18 94.76%
5 $84.69 $82.58 97.51%
6 $88.11 $88.36 100.29%
7 $91.71 $94.55 103.10%
8 $95.49 $101.17 105.94%
9 $99.48 $108.25 108.82%
10 $103.67 $115.83 111.72%
11 $108.09 $123.93 114.66%
12 $112.73 $132.61 117.63%
13 $117.62 $141.89 120.63%
14 $122.77 $151.82 123.67%
15 $128.18 $162.45 126.73%
16 $133.88 $173.82 129.83%

As you can see, given these numbers, it doesn’t make any sense to buy units for a teenager. You’re just going to get hammered down by the time-lag spread if you hold less than 6 years before redemption. Of course, it gets a lot worse if risk-free interest rates rise a lot compared to college tuitions, or if you’re paying more than 28% in tax.

However, if you think that college tuitions will maintain their higher growth rate relative to the risk rate, and if you can hold for well over 6 years, then you should strongly consider buying tuition in the GET. Why do this if you can get a higher return in a normal 529 in, say, the stock market? Well, remember that you need to beat UW’s tuition growth rate, and do so without a great deal of volatility. I’d be surprised if normal 529 plans let you use sophisticated tools like options to hedge against volatility.

I, like numerous others, believe that we’re entering a period of increased market volatility, and that if you can offload the risk of matching investment returns that are linked to a tax-free, inflating expenditure requirement to a full-faith-and-credit backed State obligation, you should seriously consider it.

Serious risks in this strategy include the possibility that Washington state politics will result in tuition increases that do not track inflation. Also, general mean reversion in higher education could threaten this strategy. I don’t think that there’s a lot of risk from falling behind a big run-up in equity prices that sustains for 15 years without a concomitant rise in inflation and tuition, but if equity returns beat my expectation and whoop up on tuition increases, you could stand to lose relative to a more traditional asset allocation. Also, waiting is not advisable; the bigger the gap between the purchase price and payout value, the longer you have to spend invested to catch up to risk-free.

Of course, remember that WA GET isn’t something you invest in for strict performance; it’s a way to cover a known expenditure requirement with lower risk. As far as I can tell, for periods well over 6 years (and ideally ~ 18 years, since you can purchase GET units naming yourself as a beneficiary and then transfer them later to your as-yet-unborn children), WA GET makes good sense.

16 Comments

  1. Thanks so much for this article Randall. It was THE article that convinced me. Your calculations are dead on and I completely agree with your conclusions. Great that you have comments working now.

    By the way did you know the new price of a WA GET Unit – $101.
    Which means it jumped by $25 from the previous price – a jump or nearly 33%. AND they may have another price increase coming in September.

    Any idea of how that will throw of any potential growth based on the math you have done?

  2. rob says:

    Dead on analysis. I used exactly this line of thinking and funded the maximum (5 years, $38,000) in March, before the price increase, for a child being born in October. When tuition jumped 14%, and with plans to jump another 14% next year, and even assuming average equity returns for the next 20 years, this low-risk/high-return strategy couldn’t be beat. I’m not convinced it’s as good a deal with the new, dramatically higher prices.

    When our son is born in the next week or two, he’ll have instate college tuition paid for. Our daughter, 2 years old, also has 500 units paid for (bought in 2007).

    Before the price increase, and given all the reasons you described, WA GET was the steal of the century. Now, I’m not so sure.

  3. rlucas says:

    Thanks for the comments (unfortunately, when I switched blog platforms I lost the pre-2009 comments). I should mention that one person who corresponded with me on this pointed out a circa 2006 publication from the WA GET trustees that showed an actuarial report saying that the plan had only a ~ 40% chance of being able to meet its obligations (and this was before the big market crash…).

    Let’s get ready to test that full-faith-and-credit piece, gentlemen!

  4. Rich says:

    REALITY CHECK for the Wash State Guaranteed Education Tuition (GET) Program !!!

    During the 2009 academic year the Unit Purchase Cost rose from $76 to $101 a 32.9% increase, however the Unit Payout Value only rose from $67.20 to $76 an increase of just 13.1%. This equates to a MINUS 19.8% LOSS of real value in just one year !!!

    Also, the GET Program allows funds to be transferred in from other 529 Plans, but does not allow funds within the GET Program to be transferred out to any other 529 Plan – This is illegal !!!

    The GET Program guarantees returns to early investors out of money paid by later investors – this is how PONZI schemes operate.

    Without question, the Washington State GET Program should be sued (class action) for their incompetence, mis-management, and horribly poor value returns !!!

  5. rlucas says:

    Rich, interesting take. I would use different language, but directionally we’re in the same spot: the WA GET is no longer a worthwhile deal (though I hold it was back in 2006/2007). To be clear: I am no longer purchasing any WA GET units for my relatives, and I can’t recommend that others do, either. (Disclaimers apply here: This is an informal blog discussion and not “investment advice,” and all opinions are those of their authors.)

  6. Thomas says:

    Hello
    I just wanted to add my take. I put money in several different investments for
    my childs college ,back in 2000. My child is about to use these investments for
    college tuition.(2010-2011). I put 2000.00 into a educational Roth. Current value >250.00. 2000 into a savings account. current value 2600. Bought patriott bonds 2 at 250.00 each. current value=500 each. I discovered GET at the same time. I bought 400 units at $42.00 a unit. Ten years later my units are worth 76.00 or more for 2010-2011. This worked out great for me. 16,800 is worth 30,400 refund value. I can even get a cash refund if I need it. This is a nice 80% return on my investment. Remember this was a guranteed value investment. The stock market was terrible during this time period. I have a roth IRA that has only recentley recovered back to my original principle over the same time. (sad). I am a decent numbers guy. Therefore I will not touch this investment until we have used our other resources. Reason is that the payout amount is skyrocketing. Four years from now I might request a payout. Like you said, look at the spread between unit purchase and payout. I think 25% is likely if I wait a couple years.
    The FAFSA form is a report of parent/child assets to measure financial need. If you open your (get) program so a grandparent owns the (get)account…its not an asset to the parents or child. The gift tax advantage is great if the grandparent is financial strong. Best of luck to everyone. Great article.

  7. Scott says:

    Thank you for the informative and enlightening article. My wife and I are trying to decide how to invest for our child’s college. We are attracted to the GET program because we like the idea of not having to manage yet another investment account and, of course, its tax benefits. Unfortunately, with the large buy-in price hike this year (now $101 per unit), our savings decision is not simple. We would very much appreciate your feedback on the following analysis:

    – Our child is 1 year old and therefore we have ~17 years before we will use the money.
    – We can fully fund the GET program this year (500 units).
    – Based on data provided by the University of Washington, we calculated the average increase in undergraduate tuition for the last 11 years (1999-2009) at 7.8%.
    – To estimate the cost of tuition in 2027, we took the total tuition/fee cost at U-W for this year (2009-2010, $7692) and applied 7.8% increase per year to reach $29729 per year.
    – Based on GET’s pay out calculation method, the payout per unit is 1/100th of one academic year’s tuition and therefore we estimate that 100 units will payout ~$29729 dollars in 2027.
    – If we fully fund now, we will need to pay $50500 ($101/unit X 500 units) and based on the above estimation 500 units will payout $148644 in 2027 (5 X $29729). This is about equivalent of investing this money at 6.5% APR (tax free).

    Based on the above analysis and especially since we have a long horizon, even with the large buy-in price increase, it still seems like a pretty good deal to potentially get 6.5% interest “guaranteed” for 17 years. Not having to “manage” the investment or worry about it until 2027 is also very appealing. Even if tuition doesn’t increase at 7.8% and the pay-out ends up being more like 5% increase, that’s still not bad for a “secure” investment.

    Please let us know if you think the above analysis is reasonable or if we are missing the boat. Thanks.

    References:
    http://www.washington.edu/admin/pb/home/pdf/tuition/2008-09-tf-history.pdf
    2009/2010 at $7692 http://www.washington.edu/admin/pb/home/pdf/tuition/2009-10-tf-annual.pdf)

  8. rlucas says:

    Scott,

    Good parts of your analysis:

    – Purpose-matched investment that is “secure.” Meaning that, because it’s matched to a known future obligation, it removes some of the risk of not being able to meet that obligation. NOTE that the only reason you can say that while still recognizing that you might be getting a good deal (that is, outpacing the market) is the “full faith and credit” guarantee of the state. Anything below the state level is NOT something you can rely upon for a “good deal” (which invariably is a bad deal for the counterparty). Look up “Washington Public Power Supply System” for a fun read.

    – Long, long horizon.

    – Thinking about tax-free vs. taxable investing (though in fairness, in a self-directed 529, you should be able to get tax deferral benefits).

    – Sunk cost mentality. You can’t invest at last year’s price, only at the current price, so don’t fret over whether it was better then.

    Bad parts of your analysis:

    – High tuition increase estimate. I know it doesn’t seem like much, but if you use 6.8% (or heck, 5.8%) instead of 7.8%, it’s a material difference in the final outcomes. I’d take the over on 7% over 17 years but just barely — you’ve got now state law capping tuition rises (meaning they’re going to game the system, creating a bunch of expenses for students but not calling it “tuition” — just you watch! — and thereby introducing risk of you having extra obligations to meet), you’ve got a massive period of deleveraging and weirdly low interest rates, maybe even deflation on the horizon.

    – Major, major flaw: opportunity cost. I think most assets are roughly overpriced (as of Jan 2010) but there are some reasonable long-term ways to get yield. As I mention above, an IRA-like 529 plan should give you the ability to invest in e.g. long corporate bonds, plus you can get pretty decent returns tax-free on longish munis. Also, I think it’s very likely that in the next 5 years there will be some “screaming buys” and I’d probably want to stretch a little for yield, rather than locking it in to the current GET regime. Now, that’s a gamble and an opinion, but I also think it’s likely that GET and/or UW will play some games and that GET alone won’t match all of your obligations, so getting some yield outside that scheme would be good. But for purposes of feedback, the key thing is a full and fair accounting for opportunity cost.

    Thanks for the comment.

  9. pamr says:

    Hi..Thanks for your feedback. That being said, I want to start a college fund for my 10mon old granddaughter. I can not buy a full fund at this time but would like to get started on a monthly plan. The concern for me is if I set up the Wa state GET monthly plan, a 7.5% fee is attached. This bothers me. I could do a 529 savings plan but know nothing about dealing with the stock market. I understand that I can buy managed 529 plans from other states. Are these a good deal and let someone else manage the plan. There are also fees attached to these I am sure. How will this affect my income tax return. Would it be set up in her name and I would the owner? I am not sure what to do. Is anyone else in this situation??? Thanks

  10. rlucas says:

    Pam, thanks for the note. This article is well out of date (for example, I no longer as of this date agree with its main premise).

    It sounds like you need a trusted financial advisor. I recommend trying to find a “fee only” guy whom you can pay by the hour to talk to and who will walk you through what you should do, but won’t sell you anything. That’s general advice, folks: never trust recommendations from a commission-based broker, and only use %-of-assets type advisors if you have a good reason to do so.

    Also, it sounds like you need to spend a few hours reading up on 529 plans; some of your questions are quite basic and you can get them answered with some reading. Your intuition and suspicion about fees will serve you well. Good luck.

  11. rob says:

    WA legislature recently passed legislation allowing universities to set their own tuition, capped at 15% in any one year and 9% annual average over any 15 years. Did the governor sign it?

    As I said above, I cannot recommend WA GET at $101/unit which is about a 30%+ premium over current tuition rates. I agree with rlucas’ analysis – the fixed guaranteed return is not high enough to outweigh the lack of flexibility in the investment. Regrettably most asset classes are now fully or over-valued, meaning there’s not a great alternative right now.

    Were I starting from scratch, I would not invest anything in GET right now.

  12. Aparna says:

    Hello,
    I think the article and the following comments have really given us food for thought about college funds for our kid. I had one question: How do I get current data about payout and so on? Could you please tell us your sources or update the data with a follow-up post (whatever you are comfortable with)?
    Thanks again,
    Aparna

  13. John says:

    Unfortunately, Thomas is the only one who has given the “real world” scenario and was able to illustrate it with retrospective information. The only valuable tool is analyzing anything. Everyone else is using prospective analysis (using past history as its function) and that is what we call predicting the future…which is impossible!

    Thomas’ story is the main reason an individual should consider the GET. Paying for college education is likely the only significant investment that is specifically time based with a small window of redemption. The likelihood is that your child will, at the age 18, attend college and that will be a 4 year process. Can you predict (no you cannot) the state of the economy, therefore, the value of your investment, during that four year period?

    Over the long term, a conventional 401/IRA or the like will probably outperform the GET. But, what will your IRA be valued at during that specific 4 year period when you need to cash it in. It is possible you could use your entire investment in the first year of school if the market performs like it actually did in 2008-2009.

    This is not a recommendation for the GET, just don’t get caught up in future analysis using percentages that all suggest the Evil State has masterminded a plan to bilk poor hard working folks out of their child’s future.

    It is all based on risk….therefore spread it around.

  14. Roger says:

    Hi,

    I’ve been trying to read as much as I can about the WA GET Program versus 529 Plans. Thank you, Randall, for your really helpful post.

    Moving forward, I still can’t determine what is the better option moving forward. I have three kids, 6, 3 and 2. They each have a little more than $5,000 in the Utah UESP 529 Plan. They also each have 25 units in the WA GET Program, at a price of $101 each. Is the GET just becoming a worse and worse deal, particularly given that tuition this year at the UW is $8,700/yr (or $87 per unit vs. $117 in the GET).

    Reading this thread, Randall states that he no longer recommends the WA GET Program. Have others as a result, moved their college savings to 529s instead?

    I’m really struggling with what a 529 will be worth in ~12-16 years versus the yearly rises in tuition. It seems to me that tuition is raising well in advance of inflation and the stock market, which would seem to make the GET a no-brainer, but then once the premium is added, I get all messed up (citing my $117 vs $87 example from above).

    Like all of us here, I’m just trying to do what’s best for my kids, and I’m struggling with what to do. I’d really appreciate any additional insights Randall or others on this topic may have. Advice welcome!

    Thanks, folks,
    Roger

  15. […] over three years ago, I wrote a post entitled “The Washington State 529 Program (GET) Offers an Overlay.”  The post has since been the most-commented on the blog (many other comments having been […]

  16. […] you use the 5.25% risk-free return from the excellent analysis Randall Lucas did of the bid-ask spread back in 2006, the WA GET Plan hardly looks like a deal. […]

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