College Savings Initiative

The Potential of Inclusive 529 College Savings Plans

Policy Options for Expanding and Improving 529s for Low- and Moderate-Income Families
May 2010 |
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The Importance of College Savings

There is strong evidence that attaining a college education is one of the best ways for low- and moderate-income students to climb the economic ladder. However, these students are less likely than their better-off peers to attend college and, if they do, less likely to graduate.[1] One new and innovative strategy for addressing this shortfall is to promote and facilitate college savings among low- and moderate-income students and their families. 

College savings can help address the rapidly increasing cost of higher education, which is a major barrier to college access and completion for low- and moderate-income students. Average college tuition and fees have risen at rates well above inflation for several decades, and this disparity has grown worse in the current decade. At the same time, average student debt loads have reached record levels, particularly for lower-income students.[2] Savings, even in relatively small amounts, can make college more affordable for LMI students and make them less dependent on burdensome student loans.

Even more important, there is evidence that savings can change the expectations and behaviors of students and their parents when it comes to higher education. An emerging body of research has found a relationship between savings and important educational factors such as high school graduation, college attendance, and completion of a degree.[3] The theory is that having even modest college savings can change the expectations of students and parents, which might lead students to work harder in primary and secondary school and see higher education as a more realistic goal. 

The Role of 529s

Despite the importance of college savings, not enough parents have started saving for their children’s higher education, and many of those who do save are not saving enough. According to a recent survey by Sallie Mae and Gallup, the vast majority of parents (nine out of 10) indicated that their child would probably pursue a college education. However, only six out of 10 parents have started saving for the cost of higher education, and only one-third of low- and moderate-income parents are saving for it. Furthermore, of those who are saving, only 29 percent are on track to meet their college savings goals.[4]

One major barrier to college savings among low- and moderate-income families is their limited income. However, extensive research has demonstrated that when given access to the right incentives and structures, the poor can save.[5] 529 college savings plans are capable of providing many of these structures and other features, making them one of the most promising vehicles for helping low- and moderate-income families save for their children’s higher education expenses.

529 plans are tax-advantaged savings accounts that families can use to save for college costs. They are administered by the states and overseen at the federal level. Although they are among the most popular, accessible, and financially attractive options for saving for college, the benefits of these savings vehicles are targeted more at middle- and higher-income households. Low- and moderate-income households are ineligible for most of the 529 tax advantages and certain other incentives. 

There are, however, a multitude of enhancements that can make 529s more inclusive and beneficial to low- and moderate-income families. Proposals to improve 529s and facilitate college savings by families of all incomes have recently begun to gain traction on both the federal and state levels.

Advancing College Completion and Savings

Last year the Obama administration and Congress introduced several new proposals for increasing higher education access and affordability, particularly for low- and moderate-income students. Some of these reforms, such as expanding Pell Grants and altering the student loan program, became law earlier this year as part of the Health Care and Education Reconciliation Act of 2010. However, some of the other proposals to promote college savings, such as simplifying the Free Application for Federal Student Aid (FAFSA) and creating a College Access and Completion Fund (CACF), were not included and are still awaiting legislative approval. Simplifying the FAFSA would remove disincentives for low- and moderate-income families to save, while the CACF would provide funding to states to test college savings initiatives. The U.S. Treasury Department also recently completed a report that analyzed 529s and made recommendations for improving their effectiveness.

There are many additional steps that can and should be taken to help low- and moderate-income families start saving for college and ultimately increase the number of students from these families who graduate from college. This paper provides a broad overview of policy options for improving 529s.[6] It begins with some background on 529s, along with an analysis of their current weaknesses and greater potential. It then discusses options for states and the federal government in five categories: student financial aid policy, tax policy, savings policy, administrative policy, and workplace policy. Some of these options are established reforms that have been enacted at some level, while others have potential but have yet to be fully developed and implemented. The overall purpose of this paper is to highlight some of these emerging proposals, as well as best practices by states, that advance this promising new strategy for helping more low- and moderate-income students complete higher education and achieve economic advancement.

 

 To read the full paper, click here or see the attachment to the right of this page.


[1] Using data from the Panel Study of Income Dynamics, Haskins, Holzer, and Lerman (2009) report that 34 percent of children from families in the lowest income quintile enroll in college compared with 55 percent of children among families of all incomes. Only 11 percent of children from families in the lowest income quintile graduate compared with 29 percent of children among families of all incomes.

[2] According to an analysis of data from the National Postsecondary Student Aid Study (NPSAS) by Mark Kantrowitz, 86.9 percent of Pell Grant recipients who completed their undergraduate studies graduated with student loan debt that averaged $24,671 in 2007-08. This compared to 50.2 percent of non-Pell Grant recipients who completed their undergraduate studies and graduated with student loan debt that averaged $21,266.

[3] For more information on this research, see Sherraden (2009), Zhan and Sherraden (2009), Zhan and Sherraden (2010), and Elliot and Beverly (2010).

[4] Sallie Mae and Gallup (2009). How America Saves for College: Sallie Mae’s National Study of Parents with Children under the Age of 18. Reston, VA.

[5] Over the past 20 years, several different studies, experiments, and demonstration projects have shown that the poor can save. These include the Saving for Education, Entrepreneurship, and Downpayment (SEED) initiative, the American Dream Demonstration (ADD), and a retirement savings experiment by H&R Block and the Brookings Institution. There is less research on the poor saving specifically for college; however, the Sallie Mae and Gallup survey found that low- and moderate-income families who are saving for college reported saving a higher percentage of their income (7.5 percent) than the average percentage for all families (3.6 percent).

 

[6] For additional information on state policy options, see Lassar, Clancy, and McClure (2010).

College savings can help address the rapidly increasing cost of higher education, which is a major barrier to college access and completion for low- and moderate-income students. Even more important, there is evidence that savings can change the expectations and behaviors of students and their parents when it comes to higher education.

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