The President was right (though politically clumsy) to go after those luscious 529 college accounts

At the State of the Union, President Obama proposed limiting the tax advantages of 529 college savings accounts. If you’re an affluent college parent, you probably already know this. If you’re not a parent and/or you are not affluent, you probably said “Huh? What is a 529 account?” Which rather exemplifies the problem.

I have 529s for both of my daughters. I recommend these to all my friends with children. These accounts allow you to accumulate tax-free investment gains to help finance your kids’ college. These also provide a good mechanism for relatives to chip in on birthdays and holidays. Given time to accumulate interest, a few hundred dollars a year from Grandma can easily accumulate to cover a whole semester at a state college. 529s provide a convenient nudge to help you save more, too, though the net impact of such tax-advantaged savings vehicles appears to be quite limited.

The president’s proposal produced an entirely-predictable uproar among affluent families and within the industry of financial and college-savings advisors.  Leading Democrats such as Nancy Pelosi and Charles Schumer immediately ran from the proposal.  Political heat was so intense that President Obama was forced to beat a hasty retreat and to abandon the proposal….

 This proposal was dead on arrival in the current congress. The administration advanced it to frame the debate moving forward for the next president and the next congress, to emphasize the need to redirect spending and tax breaks away from the affluent towards low-income people and the middle-class.

Unfortunately, the amateurish way this proposal was presented—and the virtual complete absence of supporting details–virtually guaranteed the opposite outcome. The administration had many politically possible options to reform 529s, and to curb the regressive structure of current college savings subsidies. I don’t know why the administration didn’t release a sensible 1-pager with relevant details, showing how families at different income levels would be affected by different policies. That’s too bad, because this program deserves to be reformed.

Moerover, there is something unseemly about affluent taxpayers becoming so irate when someone threatens to take away our goodies. The Government Accountability Office (GAO) issued a fascinating report describing who in America actually owns 529 accounts. Only about three percent of families do. According to the GAO, the median annual income of 529 account holders was about $142,000. Median financial holdings (which do not include housing wealth) were about $413,000. GAO indicates that this is about 25 times the typical financial wealth among families that don’t have 529 accounts.

If anything, the GAO figure understates the extent that 529 subsidies tilt to the affluent. Its wealth figures included only financial assets. The underlying data were also from 2010. The Dow Jones is up about 70% since then. GAO indicated that the median amount in 529 accounts was about $14,700. The families that actually hold larger amounts–and thus getting large subsidies–are vastly more affluent than other parents who are putting their kids through college.

I happen to be one of those fortunate parents. I’m not in the top 1%. But I am a diligent saver and a modestly-successful investor with an income that puts me roughly in the top 5%. Tax-advantaged savings vehicles are perfect for me. The 529s surely nudge me to save a bit more. It’s great to X-out that “I’ve got college covered” mental accounting box. These accounts have absolutely no bearing on whether my kids will attend college. The 529s merely provide a tax-sheltered parking space for money I’ve already saved.

There’s real money involved, too. My tax-sheltered college-savings investment gains total about $45,000. Almost all of my investment gains accrued after 2010, and thus would not be included in the GAO’s widely-cited data. I’m not writing this to boast about my wealth. Tens or hundreds of thousands of other parents did the same thing and earned the same market returns. President Obama himself established a big 529 account for his own children. He’s probably as happy as I am to pocket the tax break. He’s definitely right that there’s no reason for the American taxpayer to subsidize our kids.

I hope the president builds on his proposals to shift the various tax subsidies down the income scale to really help middle-class and working parents who face punishing college bills.

Those of us who have most benefitted from the recent bull market could whine a bit less, too. We should be more conscious of the ways that we benefit from tax subsidies and gimmicks unavailable to most Americans. We’re makers, but we’re takers, too.

With so many other families struggling with college expenses, we could take a little less this time. Other people need this more.

Author: Harold Pollack

Harold Pollack is Helen Ross Professor of Social Service Administration at the University of Chicago. He has served on three expert committees of the National Academies of Science. His recent research appears in such journals as Addiction, Journal of the American Medical Association, and American Journal of Public Health. He writes regularly on HIV prevention, crime and drug policy, health reform, and disability policy for American Prospect, tnr.com, and other news outlets. His essay, "Lessons from an Emergency Room Nightmare" was selected for the collection The Best American Medical Writing, 2009. He recently participated, with zero critical acclaim, in the University of Chicago's annual Latke-Hamentaschen debate.

3 thoughts on “The President was right (though politically clumsy) to go after those luscious 529 college accounts”

  1. Here's the problem with 529's that nobody seems to notice: The net result is that rich kids pay less for college than poor or middle class kids. The reason: Middle class or poor kids, especially those who have to take out loans, pay after tax dollars for their tuition. Rich kids, to the extend of the earnings of the 529's, pay before tax.

    Assume for a moment that a 529 is used to finance all of a kid's college education and that one-half of the money is from earnings. Assume that the college costs are $200K (4 years @ $50 per year). The cost to the parents, assuming a 40% marginal tax rate is $225K.

    The middle kid borrows the same $200K, but manages to pay it back, without interest. The cost to that kid is $250K. But wait, the middle class kid does pay interest. Thus, the after tax cost is probably twice the $250K. In other words, effectively, the middle class kid paid more for the same college education as the rich kid.

    And, of course, because of the middle class kid's indebtedness, he or she will likely have to pay a higher interest rate for a mortgage on that first home and will have a more difficult time starting a business, etc.

    And we wonder about what's causing the growing wealth gap?

  2. I don't know yet how I think college funding should get fixed. It would be great if we could find a way to make it free though, and yet on the other hand, provide good career paths for all those adjuncts. Still, I had a reaction to the line about how there's no reason taxpayers should subsidize your kid. Well, not so fast. I mean, on the whole I might agree, but then what about kids who rebel and want to major in dance instead of accounting? What if Mama and Papa Bear pull the funding? I'd want rebellious liltle McRichie to be able to study dance. It creates jobs for dance teachers! Well, what can I say, I'm a liberal. Do we really know the value of any kid, such as to say, I don't care about *those* ones? Of course there are bigger problems to fix first — but I don't know if having us all not care about others is your best argument. Plus it would undermine Social Security too. Anyhoo. I still don't even know if I am against 529s. I mean, if we're going to tax preference anything … why not college? Unless it drives up costs for everyone else … but I thought it was the student loans doing that? No?

  3. The median net worth of African-American households in 2013 was $11,000; of Hispanics, $13,700 (source: Pew). That's total net worth, including home equity and cars. To a first approximation, median net financial assets will be zero or negative. Shifting tax breaks for saving down the income scale will benefit the American middle class: this is worth doing, both in itself and to rebuild a robust progressive coalition. It won't reach the poor.

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