The other day, I saw an article from the Boston Globe suggesting Congress should eliminate college savings. When I saw the title, I instantly thought it was questioning whether college savings accounts should be banished because they disproportionately benefit the high income.
Turns out, I was wrong. It was actually about a proposal called Beyond Tuition from the Center for American Progress. For those interested, it proposes that families pay a percentage of their incomes towards college, as opposed to what they’re currently obligated to pay.
So what made me think it was about eliminating the college savings account benefit? I assume it’s because this is a debate I’ve seen around before. So, in typical CMO fashion, since it was on my mind I thought I’d write a bit about the topic.
The Facts
Back in 2015, there was a proposal from then-President Obama to eliminate 529 college savings plans. It was only around for a week before it was dropped, given the outcry of many who had started saving in these accounts.
Why did the proposal come about in the first place? It was thought that the accounts advantaged the wealthy, and taking the tax break back would help the middle class.
Consider the following data:
Most of the accounts are held by those in higher income brackets.
| Income Percentile | 2007 | 2010 | 2013 |
| All Households | 3.1 | 2.2 | 2.5 |
| 0-49.9% | 0.5 | 0.1 | 0.3 |
| 50-89.9% | 3.8 | 2.3 | 2.9 |
| 90-94.9% | 12.5 | 9.5 | 7.9 |
| 95-100% | 14.8 | 14.9 | 16 |
The original proposal mentioned “70Â percent of account balances are held by households making more than $200,000 a year”, although I could not find the original source for this claim.
The GAO has estimated that only about 3% of families have education savings accounts, and those that do, tend to be wealthier. In fact, the median net worth estimate for families with either a 529 or a Coverdell was $413k, as compared with a median of more like $15k for the general population. You can read more in this detailed GAO report.
Tax benefits are often touted as a great benefit of 529’s, and they are. But they only benefit a family if they…pay taxes. The more taxes you pay, the more beneficial the savings. About 44% of people don’t pay federal income taxes, which could make a tax benefit irrelevant to them. And if your income is below $38,400 (in 2018), your capital gains rate is zero.
This means there are lots of people who don’t actually get a tax benefit from these types of accounts. There are states with zero income tax, and only 30 states offer a tax benefit on 529’s.
If you live in a high-tax state like mine, and your state offers a tax deduction on 529’s, almost everyone will get a tax benefit (you can see our lovely tax brackets here). So for us in Connecticut, a 529 almost always makes sense. Other states, the picture isn’t as clear.
And if you live in a state with a progressive tax system, which most of use do, the more money you earn the more you stand to save in taxes with a 529 deduction. Those at the highest income levels, paying the highest taxes, will benefit the most dollar-wise from a deduction.
Bonus – Do you know what the most common way to actually save for college is, according to How America Saves For College?
Savings accounts. Forty-five percent of people use savings accounts.
Saving For College From Low To High Income
I started my first 529 college savings account for my oldest son when I was 24 or 25 years old. Back then, I was earning $35k per year or so, and my husband was working part-time. Combined we made well under $50k in a high cost of living state.
And yet, I opened a 529. Why did I decide to do that, when the tax savings were negligible?
Because I was thinking very, very long term.
I had done a lot of reading on personal finance and investing over the years, and I knew the longer I had to grow this money, the more it would compound. My son was a baby. I had decades until this money would be needed.
Given that we had many years at play here, I figured I might earn a few thousand dollars in gains. And save a few hundred bucks in taxes down the line. That would pay for…at least one book.
Which was better than no books!
The immediate savings in state income taxes weren’t a factor in my decision. Why not?
Because back in 2004 when I opened the account, they weren’t available in my state. Deductions in Connecticut didn’t start until 2006. I opened the account with Vanguard.
I will tell you, for certain, the state tax benefits are much more valuable to me now then they were back in the late
Closing Thoughts – Are College Savings Accounts For The Wealthy?
Although most of the benefit of tax savings, and the account assets, are held by the higher income, I still think there’s value in 529 accounts for those that are lower income.
When your children are young, you don’t know where they’ll end up in 18 years when they go to college.
But you also don’t know where you’ll end up.
You might be like me, and reach income levels you wouldn’t dream of back at 23 when you first became a mom. Or you might have modest income growth, but still reach a point where you would be subject to those capital gains taxes.
Even if your total tax savings are “only” a few hundred dollars, that’s real money! It’s just like you picked up $200 or $300 on the street. You could use it to buy that extra book, or some more school supplies, or help put a little bit more towards tuition.
And even small savings in taxes add up to real money over long periods of time. If you save a small amount in taxes every year for 18-22 years (remember, you can contribute to a 529 while they’re in college too!), that also adds up to real money.
So no, I don’t think college savings accounts are just for the wealthy.
But I want to know what you think.
Let me know (respectfully, of course, as always) in the comments.
I would think those with a lower income should go for the college savings option even more, since the “wealthy” would be able to handle the expense easier without savings. But that’s rarely the case. I grew up on a low income and my mom always told me “you better be smart because I have no money to send you to college.” So I put myself through school on my own.
I’m not a huge fan of 529’s, but believe 529’s are useful for all income levels.
One of the best things about 529’s is that it makes the money inconvenient to spend. When surprise bills come up, families may be tempted to raid a savings account, but 529’s are more difficult to tap.
In Virginia, we are eligible for a $4,000 deduction which takes a couple hundred off the state tax bill. It is only a minor benefit. I move the money in and out of the 529 just for that deduction. I move $4k into my son’s account, and then withdraw it a month later. He is currently in college. I then move the money into my daughter’s account. She is a junior in high school and has built up to $12k from the last 3 years. I end up with an $8k state deduction each year.
I don’t like the limited investment choices in Virginia. I don’t like that the 529 money increases the parent assets and therefore students Expected Family Contribution when filing the FAFSA.
If a family isn’t already taking advantage of a Roth-IRA, the Roth has many advantages over 529’s.
As the parent of a high school senior who is anxiously awaiting admission decisions on 1/31/19, I learned a bit about college costs and the net cost of attendance recently. We have been very diligent about saving for college via a 529 since our child was born. Quite frankly, we are in a position where we will not qualify for needs based financial aid at all, so we will be paying for any costs beyond merit based scholarships with 529 money. I think the important thing to note is that higher income families will likely not qualify for needs based so they will need a vehicle like a 529 more than lower income families might. It’s also been great from a psychological standpoint to simply set this money aside monthly and not even feel it’s available for other purposes. Here is a link to a FASFA calculator if anyone wants to see what they might or might now qualify for: https://studentaid.ed.gov/sa/fafsa/estimate
Purely from a tax standpoint, 529s give more bang for the buck to those in the highest tax brackets.
Because the wealthy sort of get screwed with all the tax breaks others enjoy because of phase outs (I was not able to deduct student loan interest for example) I do not feel guilty contributing to this.
It serves as an incentive for people to save for their kids education and that benefits kids of any family income level.