RESEARCH

Who Benefits from College Savings Plans?

The new, government-sponsored college savings incentive programs sound great — tax breaks, for starters — but are they really the best way to go for everyone?

Not necessarily, says Kennedy School Professor Susan Dynarski MPP 1995, who has been studying the federal Coverdell Education Saving Account (or ESAs) and the state 529
programs in her current research and as part of a larger look at inequality in higher education.

“People get starry eyed when they hear ‘tax break,’” she says, explaining that after-tax dollars saved in these programs are not taxed as they accrue or when they are withdrawn, as long as they’re used for educational expenses. “But there are hidden fees with the state programs that can outstrip the benefits. It’s like the Wild West: every state has one of these programs, but in some cases, they haven’t been savvy about them and haven’t made sure the plans are the best options.”

In the end, she says, it’s the high-income families that benefit the most from these plans, for three major reasons.

First, high-income investors profit more from sheltering income from taxation than do lower- or middle-income investors.

Second, if a child decides not to go to college, a 10 percent penalty is imposed, basically wiping out the benefit that lower-income investors would have earned if it had been used. (For higher-income investors, the tax savings is greater than the 10 percent penalty, especially because the funds are taxed at the child’s rate, which is usually much lower than the parent’s.)

Third, the ESA and 529s count as assets, reducing financial aid packages for those who most need them — the lower- and middle-income families. (Higher-income families are often not eligible for aid.)

Dynarski said that although these programs can be helpful for saving if investigated carefully, she worries that parents need to become financial experts to wade through the process.

“I fear that we’ve created a system that is most taxing for the people we most want to help,” she says. “And those who don’t know how to work the system get whacked. That’s not fair.”

To read the full report, go to http://ksghome.harvard.edu/~SDynarski/publications.htm.