The 529 Short Lived Debate

~ Laura

President Obama briefly, very briefly, suggested ending 529 plans, which are tax-free college savings accounts. The savings from ending those plans would fund his free community college proposal. He had to back down, because Republicans said that ending 529 was a direct hit on the middle class.

Economists can’t agree on the definition of the middle class. America’s median income is $53,046 per year. Depending on the economist, a middle class family can make between $35,000 to $100,000 per year.

According to the New York Times, even in the highest end of the middle class — a $100,000 per year income — few are able to put $14,000 aside annually in 529 accounts for their kids. 80 percent of the tax benefit of 529’s go to families that earn more than $150,000. 70 percent of the benefits go to families that earn more than $200,000. [edited for clarification]

In contrast, Obama’s community college plan was aimed at lower earning families.

Do we need to seriously rethink access to higher education?

UPDATE: Note that I have edited this post somewhat. I still would like to know the average yearly income of families that have fully funded 529s for two children.

Published by Laura

38 thoughts on “The 529 Short Lived Debate”

  1. Actually, wealthier families get a greater tax benefit, because they save more. But 70% of the accounts are held by families who make less than $150,000 a year.

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  2. Laura: “70 percent [of families who have 529’s for their kids] earn more than $200,000.”

    Megan: “But 70% of the accounts are held by families who make less than $150,000 a year.”

    I’m having a hard time figuring out how both of these statements can be true.

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  5. Maybe the difference is fully-funded 529’s versus 529’s that were set up but only have $500 in them?

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    1. Yes, most people can’t save $14,000 a year, and that’s where the tax breaks really kick in. Someone making $50,000 who puts away $2,000/year isn’t getting much in tax breaks, but a person who makes $150,000 and puts away $10,000 is getting a lot more.

      One issue is that the wealthy people who save up enough to pay the full ride anywhere are basically subsidizing the less wealthy who get aid. My friends who are writing a check (I assume out of a 529 account) for $60K/year to their daughter’s college are helping to support someone who was only able to put a little away for college (like my friend who is a single mom and probably *makes* $60k/year).

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  6. In the northeastern suburbs, if you bought a house in a suburb with a good school system after the year 2000 and are raising a family, you probably can’t live on $100,000, let alone save for college.

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  7. You misread it because it is poorly written:

    “Of the roughly seven million existing 529 plans, about 80 percent of the tax benefits go to households above $150,000, supporters of the Obama proposal say; 70 percent go to households with incomes over $200,000. That is because those people have the most money invested and can contribute $14,000 a year or more without worrying about reaching federal gift tax limits. Investment gains can then be used for education expenses without a capital-gains tax.

    In 2007, the Obamas themselves illustrated the president’s point, front-loading five years’ worth of contributions into their daughters’ 529 plans, with deposits of $240,000.

    But according to the College Savings Foundation, a consortium of financial institutions backing 529s, measuring tax benefits tells only part of the story. Close to 10 percent of 529 account holders have incomes below $50,000, and more than 70 percent of the total number of accounts are owned by households with incomes below $150,000.”

    There are two numbers here: how many families have accounts, and who gets what percentage of the tax benefit. Wealthy households have larger accounts, and higher marginal tax rates, so they get most of the overall tax benefit. But the majority of accounts are held by families with more modest incomes, who get some tax benefit, but not as large as someone with a 42% marginal tax rate who is liable for the special 4% Obamacare surtax on capital gains.

    This misunderstanding seems to be incredibly widespread, possibly because the administration is trying to strenuously imply your reading, rather than the correct one.

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    1. I’m not sure the number of accounts is by itself relevant. I’d like to see the number of non-trivial accounts. Say that had $1,000 put into them in the past year or have a total value of over $5,000. Because enabling a bunch of people of relatively poor people to save $250/year is probably more deluding somebody into thinking they are saving than actually helping.

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  8. Some thoughts:

    1. A lot of people currently go to community college who can’t benefit from it. I’m happy to tolerate that at the current level because of the great benefits when a person who can benefit from community college goes (my CC teacher relatives have some amazing success stories), but I do not see the need to throw yet more money at the no-hopers. And yes, there are a lot of people at community college whose presence is a total waste of the taxpayer’s money.

    2. For many community college attendees, community college is their second shot at actually getting a high school education, and many fail at that. Heck, a lot of them fail at getting an 8th grade education at CC. In many cases, it’s not really about getting a HIGHER education.

    2. It’s quite true that college savings are not something that moderate-income people do, nor should they. Moderate income people should (as a rule) be putting more into retirement and only putting money into college once there’s overflow (which in most cases, there won’t be). Dave Ramsey says to start college savings once 15% of income is going into retirement, which very, very few people are doing. We’re planning on breaking that rule and starting college savings this summer but 1) my husband’s employer’s contribution to his retirement is very generous (it’s 10% of income, as I recall) so even though our own contributions are pitiful, we have something like the equivalent of 11% of income going into retirement yearly 2) our oldest will hopefully be in college in 5.5 years and 3) we can’t reasonably expect need based aid and in 8.5 years, we are facing a calendar year with roughly $50k in school costs (that’s assuming two kids at the equivalent of UT Austin and one kid in private school). We need to make a running start and take the edge off that one BAD year.

    4. It is a pretty important point that unlike lower income families, the high-earning families that are the primary beneficiaries of 529s are not going to get need based aid. The tax-advantaged accounts are the only help they are going to get, and their private tuition (if they go to private colleges) is already subsidizing needier students. That’s baked into the private college pricing system.

    5. There are some concerns that 529s just help inflate college costs, because colleges respond to the presence of money with tuition hikes and that 529s are more a subsidy to colleges than an actual help to families.

    6. That said, attacking 529s has a lot of symbolic value with regard to raising fears that other tax-advantaged savings (for instance retirement) will not be viable long term. Aside from the actual benefit to the families (which may be an illusion if my #5 is true), the existence of 529s and similar encourage savings, and encouraging savings and future-orientation is a good thing. And likewise, discouraging savings or making people think “what’s the use?” in planning for the futures is a very, very bad thing.

    7. I vaguely recall that the presence of even a tiny college savings fund is highly correlated with a child’s actually going to college.

    “A 2013 Washington University study shows that a college savings plan can encourage students to enroll and graduate from college. The report notes that promoting even a small amount of college savings, can make a huge difference in a child’s likelihood to attend college. Evidence shows that “children with $1 to $499 designated for school are 2.5 times more likely to enroll in and graduate from college than children with no account.”

    “The report notes that the positive effect from the savings account is probably the result of “mental accounting,” which is the “process of assigning money to categories, which affects when and how people use it.” It can also affect how children view themselves. Even a small-dollar savings account can help a child see him or her self as a college-bound student, an therefore make efforts to achieve that goal.”

    http://www.cashmaine.org/resources/study-shows-college-savings-plan-encourages-enrollment

    So, there may be a huge psychological value to even a tiny college savings account.

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    1. …but I do not see the need to throw yet more money at the no-hopers.

      I don’t know that you can assume additional funding for CCs would, in the aggregate, be putting more money to those who benefit least. First, there are students who do benefit but had to drop out for financial reasons. Also, you’d draw people who would have otherwise gone to far, less effective for-profit trade schools. Plus, even those who would have gone to a CC and succeeded without the new program but get it will be better situated for starting out if they have less debt or more savings.

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      1. Has anyone paid attention to how the “free” community college plan is structured? What I’d like to see is the ability to take a class when you can, without regard to overall eligibility. And, in my imaginary plan (I haven’t read the real one) unlike taking student loans (especially student loans for living expenses), you can do so without being a full time student and there is no benefit to being enrolled in the class (other than the class). Dropping (or failing) a class doesn’t produce a ripple effect of loosing eligibility for tuition grants and student loans.

        But, I don’t know how the actual plan is structured.

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      2. I don’t think you realize how much of a struggle many community college students have with even remedial classes.

        http://www.usatoday.com/story/news/nation/2013/07/25/stateline-remedial-education/2586013/

        “Research shows many college students who take developmental education classes, usually required when they score low on placement exams, fail to graduate. Only 28% of two-year college students who took at least one developmental course earned a degree or certificate within 8.5 years, compared to 43% of non-remedial students, according to one study. The study concluded the gap in graduation rates reflected differences in learning skills carried over from high school, rather than the impact of remedial classes themselves.”

        “Remedial classes are the “quicksand of higher education,” James Skidmore, chancellor of West Virginia’s Community and Technical Colleges, told the state board of education.

        “Sixty-four percent of first-time students in the state are placed in remedial English, math or both. Only 13 percent go on to earn a degree, he said. “Students get in developmental and they never get out.””

        http://communitycollegespotlight.org/content/west-virginia-avoid-remedial-quicksand_16980/

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  9. Laura, you had a giant discussion couple years ago about ‘what is middle class?’ I’m suggesting it matters, and matters for how badly the Obama people wrong-footed themselves on this issue. My suggestion is, people are middle class if they thing they are middle class. And that people who think they are middle class include a huge swath of circumstances, from folks who make $30000 a year to $400000 a year. If you meet: has enough to eat, can pay rent on a decent dwelling, clothes clean and not ragged, can keep the home heated and cooled, works for a living – probably you think you clear the lower bar. If you don’t meet: has live-in help, has a second home, expects to pay for college effortlessly out of current income, orders up a plane to take the family on vacation, has clothes tailored – probably you think you don’t clear the upper bar. There are regional differences, in Chillicothe or Silver City it costs a Hell of a lot less to rent a decent dwelling than it does in Brookline or Palo Alto.

    And if you think you are middle class, and the Obama people come up with a proposal which damages the interests of someone in that very wide swath, then you have a tendency to be prickly about it.

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    1. I think you could have an au pair in the DC metro area and still be middle class. In fact, a live-in au pair is kind of the budget option for childcare.

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    3. I would have to disagree. People earning seven figures also think they’re middle class. That doesn’t mean they are, or that we should cater to their delusions. Also, a list of “X makes you middle class, Y doesn’t”* is arbitrary and very regionally based. Owning a second home or having clothes tailored isn’t remotely comparable to ordering up a private plane. A small point, but your list is also internally contradictory: if someone can’t pay for college effortlessly on a $400K year income, they’re doing it really wrong.

      *We can get into a Bourdian discussion of class, but I’m not sure that’s what we want to base economic policy on.

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      1. Yeah, a lot of stuff is very regional.

        For instance, lots of people in places like Michigan have lake houses. A cabin in Michigan is not comparable to a second home in Malibu.

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  10. Alright. Let me fix the post. But those numbers aren’t terribly helpful.

    When Jonah was born, my father in law gave us $500 in a 529. It was a one-time gift. No more money was put in the account. We were under the poverty line at that point. There was no way we could add to it at that time. I think Steve might have closed the account and used that $500 to pay for diapers. We could never open up another account, because we have never had a spare $15K. We funded our retirement funds, paid the mortgage, and covered daycare, summer camps, and therapy.

    I wonder how many people have anemic 529s. Those with a couple of thousand in them at most.

    The wealthy certainly benefit from them for the reason that Megan explains. They get the biggest gains in terms of savings from tax dollars. In addition, I’m sure that they are the only ones who actually maintain the accounts. So, even with my clarification of the post, the conclusion is the same. 529s benefit the wealthy.

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    1. Yes, using the Obama example (which is a category that many of the well off are in), I’ll take a guess that probably at least 1/2 of my kids’ class has families with fully funded 529 plans, i.e. they’ve pre-funded 140K/5/child. Compounded until they graduate from HS (say with 15 year’s compounding, at a rate of 5%, will double to 280K/child, which can be supplemented.

      So, 280K/child, 2 children, 560K, of which 280K is gain, which will be tax free if used for education. Let’s assume that it’s taxed at the marginal rate (not correct, since some will be capital gains). Then, the family, at the 42% tax bracket, get’s a tax benefit of $117,600 (pretty nice).

      If by some miracle (rich relatives, I guess, who are only willing to fund 529 plans), the family making 50K had saved that much money (which would be foolish — even if it were possible), they’d get a 42,000 tax break. And, of course, those 10% of families making 50K do not have $560,000 in their 529 plans.

      529 plans clearly benefit the wealthy, which is the point of the numbers. But it’s also true that everyone who thought they were going to put any money in a 529 plan (as well as all the financial institutions that benefit from them) feel like they’re going to loose something. The institutions probably do.

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    2. They are post-tax dollars. The savings comes from not being taxed upon the earnings in the account, which is what this argument is about, not about the ability to sock away pre-tax dollars, which you can’t.

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      1. My math is right — the savings are the tax benefits on the earnings, and they go overwhelmingly to the wealthy. I know that 529 plans are funded with post-tax dollars. In fact, the family making 50K would actually have to come up with about $330,000 to fund those two plans.

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  12. The article points out that Democrats hated it just as much as Republicans. As we’ve discussed on this blog many times, how many families earning $150,000 or $200,000 think they are “rich?” Particularly when the Obama administration and their Democratic representatives call for raising taxes on said rich?

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    2. Families making a million don’t think they’re rich either. The word rich is relative. I used to think I’d think I was rich if I could comfortably buy a second home. But, I think now that my definition of rich might require being able to buy Lanai as a second home.

      When we’re talking about public policy, we should talk about numbers (and, yes, we can call those numbers rich, if we want).

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  13. “UPDATE: Note that I have edited this post somewhat. I still would like to know the average yearly income of families that have fully funded 529s for two children.”

    I’d like to see the analysis of the number (and average income) of people who would benefit from the continuation of the AOTC (American Opportunity Tax Credit) which is currently set to expire in 2017 compared to the currently constituted 529 plan. The AOTC is $2500/student/year for 4 years, refundable to $1500 under Obama’s plan). For the family with 2 kids making 50K (that would be worth 20K. At a 15% tax rate, they’d have to have $130,000 in investment earnings on their 529 plan in order to achieve that tax benefit. And, unlike the 529 plans, you do not have to sequester your money, ahead of time in order to receive the benefit. Married couples making up to 160K are eligible, according to my quick read of the IRS site.

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  14. People may be confused about whether or not they are rich or middle class, but people aren’t confused about whether or not they have a fully funded 529. That’s a “yes or no” type of issue.

    I think everybody in the comment section here agrees that 529s benefit the wealthy. Commonsense tells us that only the wealthy can afford them. There may be a whole lot of people with modest means that have accounts, but they probably contain silly amounts of money like our $500 account.

    Perhaps the only debate is about the politics. Democrats are tight with the higher ed lobby, so I wouldn’t be surprised if they weren’t enthusiastic supporters of Obama’s plan. Also, it is hard to take back something like this.

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    1. Also, high income Democrats living in high cost areas are probably the target audience for 529s and similar. Ditto the mortgage interest deduction, etc.

      That’s presumably why Nancy Pelosi blew a gasket over the plan.

      “But the call for the White House to relent also came from top Democrats, including Representatives Nancy Pelosi of California, the minority leader, and Chris Van Hollen of Maryland, the ranking member of the Budget Committee.

      “Ms. Pelosi pressed the case to senior administration officials on Air Force One as she flew with the president from India to Saudi Arabia, according to Democratic aides familiar with the discussions.”

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  15. Regarding the definition of “middle class,” the $53,000 median income number is misleading, because it includes all ages. HT: Kevin Drum did a good post on this point some years back. If you restrict your universe to families headed by an individual between 25 and 64, the median income is a lot higher, like somewhere in the 70s. (Retirees and students pull the median down.) And I would guess that the median income for 25-64 year olds in high cost areas like the tri-state region is even higher, though I don’t have those numbers. That is the group–nearby householders in the prime of life–to which people compare themselves in evaluating their own class status.

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      1. I’m really surprised how well TX stacks up against the NE. $423k for TX and “only” $506k for NY?

        That’s astonishing.

        CT has $678k, which is impressive, but a lot of NE states have lower numbers than TX.

        I’m also really surprised by $279k for Hawaii, as I’d always understood that Hawaii was very expensive.

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  17. I’ve managed to put a little under the average in for my older daughter and little for the younger: however, I am going to start it now and we have time. The point to me of the 529 is not so much the tax breaks, honestly. It is that it makes saving even a little for college extremely easy. I don’t know what I’d use otherwise: a savings account I could raid whenever? I just get $25 or $50 taken out of my paycheck and put directly into it: it adds up nicely and I don’t miss the money. I know there are ways to do this otherwise, but I am extremely thankful for the 529s I have for my kids even if they don’t cover their whole (or even half) of their tuition! BUT I definitely don’t think this is the answer at all.

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    1. That is a very good point about sequestering college money and making it psychologically and practically more difficult to touch it.

      We did something similar with our house savings when we were saving to buy–we opened up a completely separate and hard-to-get-to account to keep the downpayment savings in.

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  18. AmyP, Hawaii is super expensive but my understanding is that the standard of living is quite low for most Hawaiians. The middle class is generally wealthy whites from the mainland. Spam is very popular.

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