College-Savings Program Flawed at the Core

BOSTON (TheStreet) -- When 529 plans, designed for college savings, were created by Congress in 1996, they were based on the structure of 401(k) retirement plans.

The idea, and it seemed like a good one at the time, is that states could create and manage two flavors of college-savings vehicles. One would be an account plan with compounding interest. The other would offer the opportunity to pre-pay an education using an interest-bearing account that would offset inflation.

At the time, 401(k)s were all the rage, coming into their own as a replacement for conventional pensions and showing impressive quarter-over-quarter growth. Parents were thrilled by the new option. Of course, the 1990s hosted one of the greatest bull markets in history.

Parents aren't so happy anymore.

Just as the stock-market crash that started late last year ravaged retirement accounts, many 529 plans lost as much as 50% of their value. For retirement plans, bull and bear markets offset each other over the course of 45 years. But 529 plans often have less than half that time to earn money for college -- especially for those with a child ready to enter college this year or next.

Parents who went the prepaid route have just as much to worry about.

This spring, the Alabama Prepaid Affordable College Tuition trust revealed it had lost more than 45% of its value. While some states protect investors for losses, parents in Alabama weren't so fortunate. The gravity of the situation was driven home by a letter that informed them that the plan has no "legal or moral obligation to ensure the ultimate payout."