Approximately two weeks ago, the president announced an educational reform initiative that included removing the federal tax benefits from 529 plans. Under current law, savings in a 529 plan grow tax-free and withdrawals are not taxed when used for higher education. What quickly ensued was a wave of media frenzy, citizen outcry, and strong opposition from both sides of the political aisle. It contained all the elements of a riveting media story, as there are few things people get more passionate about than politics, taxes, their hard-earned savings, and children.
The president retracted his proposal for 529 plans just one week later, resulting in one of the quickest political flip-flops of all time. So how could such a high office dramatically underestimate this public furor and backlash? It's all in the math.
The proposal and the resulting media analysis were based on a 63-page report from the Government Accountability Office (GAO) titled "A Small Percentage of Families Save in 529 Plans". The study implied that only a few households even use 529 plans, and those who do are wealthy and don't really deserve a tax benefit. At Savingforcollege.com, we took a closer look at this report, as well as some more recent data, and came to a very different conclusion. Here's why:
The GAO study and the underlying data are ancient. The study, conducted in 2012, includes facts dating all the way back to 2010. That was FIVE years ago, and only one year after the Great Recession. What's more, the main 529 plan benefit was made permanent in the tax code only four years earlier, in 2006. I think we can all agree that things have changed since then. In fact, 529 plan participation has risen so dramatically over the last few years that management fees have dropped significantly as a percentage of total assets.
The study takes into account ALL families, not just those with children. The GAO is circulating the stat that only 3 percent of American families use 529s. This fact is so misleading it's almost a joke. Yes, 529s can technically be used by anyone, but 88 percent of 529s are used by families with children. Come on, GAO, you can do better. In 2010, the actual usage number was approximately 6.8 percent of families with children, and in 2014, well it's closer to 17 percent!
In 2014, approximately 16.8 percent of families with children use a 529 (and increasing). Sure, 3 percent of families might have seemed like only a "few" to the policy makers, but we're really talking about cutting tax benefits that affect close to six times that amount. And we're not even considering the families who were intending opening a 529 plan in the near future. The resulting public outcry was inevitable.
Data presented were based on a study of just 195 households.
The report surveyed 6,432 families and concluded that 3 percent had 529s. This means that a total of 195 families were participating in a 529 plan. There were approximately 118 million households in 2010. Using the report's numbers, that would bring the numbers of families with 529 plans to 3.5 million. This is hardly a large enough sample size to proclaim that most families utilizing these plans are wealthy, let alone be the basis for any kind of economic or educational policy.
The percentage of lower-income families using 529 plans has grown over time. A 2014 report by Strategic Insight showed that 70 percent of 529 accounts are now owned by families with household incomes below $150,000. Savingforcollege.com, a leading provider of unbiased 529 plan information, ran a survey and found that 73 percent of people intending to open a plan within the next 12 months had incomes under $150,000.
Admittedly, is this household income closer to upper middle class? Yes. But anyone who has seen the news knows that unless you are truly wealthy, the need to save is absolutely necessary. These are families that in many cases no longer qualify for financial aid, yet at the same time can't afford tuition payments in their monthly budgets.
The tax benefits of 529 plans are a proven incentive to save. Since the Bush tax cuts in 2001, when 529 plans became federal tax-free, total assets in the plans have risen from $19.4 billion to $254 billion. According to the College Savings Plans Network, the average 529 account held just over $19,000 at the end of 2013. At first glance that amount might not seem like a lot, especially considering one year of college at a public school will cost you over $18,000. But let's consider the fact that plan balances are experiencing tremendous growth. Average account balances increased by 14 percent from 2012-2013. If that rate of growth continues we could start to see a significant decrease in student borrowing. In any case, savings that pay for one year, or 25% of total college costs, is hardly pocket change.
Finally, the tax revenue estimate was flawed and insignificant. The president's team estimated that the proposal would generate $1 billion in tax revenue over 10 years. Currently, Americans invest approximately $20 billion in 529 college savings plans each year, but of course that number would dwindle when the incentive to save is taken away. This means the policy would put $200 billion dollars of savings at risk for $1 billion in tax revenue. And let's not forget that you can't tax what isn't being deposited, so the tax revenue would actually end up being much less.
Politics aside, the president's proposal and data used were incredibly flawed. There is little surprise of the immediate backlash received. Mr. President, I commend you for quickly backpedaling and removing the 529 change from your proposal, and frankly suffering some political egg in the face. Most importantly, kudos to all families that stepped up and contacted their representatives in Washington, and to those representatives that contacted their party leadership (on both sides of the aisle) to put pressure on the president. It's nice to finally see a case in Washington where logic and reason prevail.