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State's college savings bonds: easing future cost crunch

When Springfield PTA Council President Rick Heironimus invited a representative from the Illinois Student Assistance Commission (ISAC) to speak about long-range financial planning for college, he wasn't surprised to see parents of elementary school students show up for the meeting. Heironimus believes the presence of the younger parents reflects their increased concern about future college costs. He thinks more parents would begin planning earlier if they knew what options were available. "If they're not concerned, they should be," he says.

Heironimus may be right. According to statistics provided by ISAC, in 1977 the average annual cost for tuition and fees at Illinois institutions was $397 for community colleges, $624 for public four-year universities and $2,700 for private four-year universities. By 1987, those figures had risen to $791, $1,710 and $6,809, respectively. By the year 2000, if present trends continue, those costs will nearly double again. The figures do not include books, room and board, transportation and personal expenses.

Parents aren't the only ones who are concerned. Steadily rising costs are placing increasing pressure on state and federal financial aid programs. One solution proposed by the state: Encourage parents to begin saving earlier for a child's college expenses.

This emphasis on reaching younger parents is part of the reason that the Illinois State Scholarship Commission changed its name to the Illinois Student Assistance Commission last fall. "We're changing our whole focus," says ISAC public information director Robert J. Clement. "A lot of times parents talk about a son or daughter going to college or some other type of post-secondary education, but they won't talk about the financial aspect until maybe the junior or senior year. Unfortunately for a lot of parents, that is way too late and the money is not there."

ISAC has one program underway and two in the planning stage that it hopes will address the concerns of both the state and parents worried about future college costs. The college savings bond program was approved by the General Assembly in 1987, and three bond sales have taken place to date. The two other programs, a savings program for smaller investors and a nonsubsidized loan program designed for middle-income families, are in the development stage and should be operational by this summer or early fall, Clement says.

The college savings bonds are structured as zero-coupon bonds with maturities ranging from two to 21 years. Like most U.S. savings bonds, they pay no annual interest, are purchased at a discount and redeemed at face value. Prices have ranged from approximately $ 1,100 for the 21-year bond to $4,500 for the two-year bond. All bonds are worth $5,000 at maturity.

Besides providing a secure way for parents to plan ahead, the savings bond program offers other major investment advantages. The interest is exempt from both state and federal taxes. Since few other bonds are "double exempt," these bonds are especially attractive to those in middle to high-income brackets. If the bonds are used for the student's education at approved public or private institutions in Illinois, a bonus of $20 for each year the bond was held is paid directly to the institution toward the student's educational expenses. And bond proceeds up to $25,000 are exempt from consideration as assets in the state student financial aid needs test administered by ISAC.

The program offers advantages for the state as well. The bonds encourage parents to plan earlier for college expenses, thus reducing the number who seek help from financial aid programs. The bonuses promote enrollment at Illinois institutions. Costs for the program are minimal. Since the state designates a portion of its normal general obligation bond sales for the program, cost to the state for the college bonds is no greater than for other general obligation bonds.

The Bureau of the Budget administers the bond sales, and ISAC will administer the bonus part of the bonds through direct appropriations from the General Assembly. Cost to the state for the bonus payments will depend on the redemption rate from one year to the next. Robert Mandeville, director of the Bureau of the Budget, says the obligation will be "extremely small," leveling off somewhere in the range of $1 million per year. However, the costs of the bonus payments and the loss of revenue because of the state tax exemption will be largely offset by the low average interest rate on the bonds, says Jim Ofcarcik, manager of long-term debt analysis for the Illinois Economic and Fiscal Commission.

Planned to complement the college savings bond program are the two other programs, both initiatives of Gov. James R. Thompson: the savings program for smaller investors and the nonsubsidized loan program. For fiscal year 1990 ISAC was allocated $5 million to cover administrative costs for the two programs.

The savings investment program will aid families that have small amounts of money to invest at any one time. With emphasis on convenience and accessibility, the program will probably

28/June 1990/Illinois Issues

utilize payroll deductions, monthly transfers from savings or checking accounts and third-party contributions (from grand parents, for example). "We are looking for something that will make it very easy for the parents to save," Clement says. "This program will allow them to contribute an affordable amount monthly over a long period of time."

While legislation has been introduced to make interest from this savings program exempt from state taxes. Clement believes the chief advantage of this program over other investment programs is its accessibility to families not usually able to invest large sums. By pooling the smaller investments of many families together, the families gain access to more sophisticated investment opportunities.

The nonsubsidized loan program is being designed for middle-income families who do not qualify for the federal need-based subsidized Stafford Loan program (formerly known as the Guaranteed Student Loan program). "A lot of these families have been squeezed out of the Stafford program," Clement says. The state nonsubsidized loan will not be need-based, and those receiving loans will be eligible for the same interest rates (currently 8 percent) offered by the Stafford Loans. Interest payments will not be deferred, however, and the student will

The first three issues of the savings bonds were an overwhelming success .... The state sold $93 million in college bonds in January 1988, $225 million in October 1988 and $250 million in November 1989

make interest payments while attending school.

ISAC will be the lender for the new loan program, which will be funded with bonds sold by the commission. The first offering of around $50 million is planned for later this year. The number of bonds sold each year will depend on ISAC's projected needs for the coming year.

The idea for the college savings bond program came from the Senate Task Force on College Tuition Investment Programs, created in 1987 to design a specific tuition investment plan for Illinois. The task force investigated other options, including pre-paid tuition guarantee programs tried in other states, whereby parents can lock in a future tuition rate at a particular institution by paying into the program now. The guaranteed-tuition option was dismissed because it would limit a future student's choice to only one or a few institutions, and could also prove expensive and cumbersome for the state to administer. The tax-free earnings on the college savings bonds can be used at colleges in Illinois, at colleges in other states or at the purchaser's discretion.

The first three issues of the savings bonds were an overwhelming success, according to Ross A. Hodel, deputy director of the Illinois Board of Higher Education. The state sold $93 million in college bonds in January 1988, $225 million in October 1988 and $250 million in November 1989. During the last sale, an estimated 40,000 people bought the bonds from around 500 participating banks and 85 investment banking firms. "The bonds were all sold in a very short period," he says. The next sale is planned for this fall.

Who buys the bonds? According to figures provided by First Chicago Capital Markets, managing underwriter of the sales to date, at least 93 percent of the bonds were purchased for the expressed purpose of saving for college. About 95 percent have been bought by Illinois residents. About 15 to 20 percent of the purchasers have been grandparents. (Most out-of-state purchasers were thought to be grandparents.) An estimated 65 percent of the purchasers had never before bought a tax-exempt bond.

"No one who works in the municipal bond business in Illinois has ever seen a bond sale generate as much interest from individual investors," says Mark W. Gallagher, vice president of First Chicago Capital Markets. He estimates that public demand for the bonds has been two to three times the amount of bonds available. "Each of the sales has been oversubscribed. We've tried to allocate at least one bond to each person who wanted one, rather than selling several to one individual."

The oversubscription points to a drawback that ISAC's Clement acknowledges: "Simply put, the state of Illinois has not been able to keep up with the demand for those bonds." Clement says he hopes the new program for smaller investors will provide a partial solution to the problem. Unlike the college savings bonds, there will not be a limited supply.

Budget Director Mandeville says that the state does not sell bonds to help people save for college. It sells the bonds to borrow money to build roads and bridges. In the last two years $200 million to $250 million of the $340 million in annual general obligation bond sales have been the college savings bonds. The balance of the sale "wraps around" the zero coupon bonds to give Illinois level debt service over the 20-year period.

Another concern is accountability. How does the state make sure parents will be spending the money for college? According to testimony submitted to the task force by the Illinois Economic and Fiscal Commission, there is no way short of a costly and complex administrative apparatus to enforce such a restriction. However, Hodel is not sure this is a serious problem. "The idea was to include a positive bonus if the money was used for college rather than a penalty if the student didn't go to college," he says. "It's a good investment whether or not the student goes to college and an even better investment if they do."

The college savings bond program has been extremely popular. "I think the demand for the college bonds shows that there's a crying need out there for investment opportunities for post-secondary education," says ISAC's Clement. Offering solid investment opportunities and improving public awareness of these options may prompt more parents to begin saving earlier for college, thereby reducing their need for financial aid dollars later.

Debi Sue Edmund is a Springfield free-lance writer and editor.

June 1990/Illinois Issues/29

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