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Shouldn't 529 Plans be a Part of a Middle-Class Agenda?

Adam Rust's picture

Posted January 23, 2015

How do intentions announced from the Obama administration, which if enacted would reduce or eliminate benefits from 529 plans, fit into an agenda of supporting the middle class?

If this nomenclature is not familiar to you, then let me explain. A 529 is a tax-protected account designed to protect funds designated for educational expenses. 529 plans create a long-term, systemic infrastructure to help parents fund a college education for their children. Generally, after-tax dollars go into 529s. Currently, annual contributions are soft-capped at $13,000; any contribution above that sum is exposed to gift taxes. Presumably, those monies are invested over time. When it is time to pay for college, withdrawals are tax-free as long as they go toward education-related expenses.  There are some additional wrinkles in the rules, but for the purposes of brevity, I encourage those who are interested to go to this informative link

Reports say that the President is contemplating a plan to phase out the 529. Current holdings would be grandfathered, but new contributions would lose their tax advantages.

The President attributes his motives to the idea that most participants in 529 plans are either "mass affluent" or rich.  But I think it is worth gauging that perspective against some of the research that has been on the question. To that end, here are a few highlights from the GAO's "Higher Education: A Small Percentage of Families Save in 529 Plans:"

A few undermine his argument:  

  • According to a Sallie Mae survey cited by the GAO, the median balance in a 529 in 2010 was $14,700.
  • Because people tend to withdraw over a number of years, the average distribution was only about $8,000.

Others support his assertion:

  • Participants veered into upper strata of wealth.  The GAO reported that the median asset holding among 529 account holders was $413,500.
  • Median income of participating families was $142,400 - about three times more than the average of non-participating families. 

If you think a 529 is a sop, then the next logical step would be to fight to stop the mortgage interest deduction. Seventy-one percent of families with a 529 or Coverdell had incomes of more than $100,000. But according to the Center for Budget and Policy Priorities, 77 percent of MI deductions were claimed by households who reported AGIs of more than $100,000. 

Certainly the net worth figure is much higher than the norm among American households, but there are some apples-to-oranges factors here: you cannot start a 529 until you have children and most people who are saving for college don't do so until they are older. With each passing year, fewer and fewer 20-somethings are parents. As a result, the sample excludes a low-wealth portion of the population. In fact, if you project that typical age of parents with children entering in college is north of 50, then the difference narrows further. According to the Federal Reserve's 2014 Survey of Consumer Finances, the median net worth of households led by a person between the age of 55 and 64 was $165,900.  For households led by a college graduate, median net worth was $219,400.

The 529 is the slow and steady way to pay for college.  It is a sop not to the rich, but to middle class parents who cannot qualify for a Pell Grant but who still want a way to make paying for college a little less expensive.

The Fed's SCF revealed an interesting connection between 529 participation and educational attainment. In ninety-one percent of 529 (or Coverdell) participating households, someone had a college degree. For those that didn't have a degree, fewer than half had finished college. 

Realistically, if you are going to push back on 529s, then it would be equally true to say that IRAs are only for the mass affluent. The poor do not use IRAs for some very logical reasons - most don't have dollars to put away for decades. Other mass affluent tax benefits include the mortgage interest deduction.

But the middle class will get a boost from an unusual source - the GOP.This is the President's idea, and thus the GOP will be against it.