If you are a parent who’s trying to save for your kids’ college education, you should check out Jane Kim’s article in the Wall Street Journal about 529 college-savings plans. If you don’t know what a 529 plan is, you should; and if you do, Kim’s article is helpful in assessing whether you’re optimizing your participation.
In a nutshell: a 529 is a tax-advantaged plan that helps parents save for college; each state offers its own plan but investors can choose whichever state’s plan they prefer.
The article is centered around a new Morningstar analysis of the various states’ plans and makes at least one really important point: while most investors choose the 529 plan from their own state — in large part because of a state tax deduction (and, I am guessing, because of more robust in-state marketing than out-of-state marketing) — many people would be better off choosing out-of-state plans with lower fees and better returns, which would more than make up for the state tax deduction.
Kim’s article also points out an important fact that I’d missed: “Congress in 2006 made the tax benefits [of 529 plans] permanent; they had been set to expire at the end of 2010.”
So if you are trying to save for college and have the means, there is no good reason I can think of to not participate in a 529, as long as it has low fees and a good menu of funds.
Several years ago, Austan Goolsbee warned us about bad 529’s, but I am guessing that even Goolsbee would now be happy with the transparency that’s been brought to the market by reports like Morningstar’s.
Reading about 529’s so soon after the April 15 tax deadline does reinforce for me just how random the U.S. tax code can be. Why, for instance, are there such significant tax breaks for college tuition (in the form of both a state deduction on a 529 contribution and tax-free appreciation) while there are no tax breaks at all for K-12 tuition?
The obvious answer is that you can get free K-12 schooling. College tuition, meanwhile, is rarely free. But think it through a little further.
If you live in New York, like I do, and choose to send your kids to a private school, you can easily pay $30,000 a year for tuition — more than many colleges. That’s a choice, of course: you could send your kids to public school for free. But the college tuition savings that accumulate tax-free in a 529 plan can be spent on a private or public college: there’s no distinction.
If, however, you choose to send your kids to private or parochial school, you are still paying school taxes for other people’s kids as well as the tuition for your own kids, with no tax break. (Here’s a primer on school vouchers.)
Our tax code also heavily subsidizes home ownership — a big driver in the subprime mess — while there are no tax breaks for renting your home.
And then there’s the tax-free status of religious institutions. In a country with such profound expressed respect for the separation of church and state, should this be the case? A small but pronounced example is the “parsonage” deduction, whereby members of the clergy can deduct from their taxes the amount they pay each year in living expenses — whether or not they actually lead any sort of religious congregation.
I have several friends who are clergy working at, e.g., academic or non-profit institutions, who still gain the parsonage deduction. To a person, they admit it is a ludicrous loophole; but, because they are not idiots, they take advantage of it.
These are but a few of the random tax wrinkles that make a lot of people, rational and otherwise, favor a flat tax.
From 1 to 25 of 61 Comments
Not my country, but I always thought that we pay taxes into K-12 schooling specifically because its to our individual and collective benefit for every kid other than ours to get at least that much education. People without offspring benefited from their own education and will indirectly benefit from an educated next generation, so they pay too.
As a perk, you can send your own kid, if you have one, but that’s incidental.
(In my jurisdiction (Ontario) secular public schools _and_ fully publicly funded Catholic schools are funded through property taxes)
— Eric Grant@Eric
That is the theory. But the theory assumes that these children are actually being educated. This is not the case in the majority of public schools across the US.
— HantraLink to Morningstar Article
http://news.morningstar.com/articlenet/article.aspx?id=234422
— RobertSeattleI know that my response to your question as to primary education is state supplied, and private schools are not tax deferred won’t warm the average economist heart, because at its core is the concept of the public good.
Primary education provides a value to society that everyone, even those without children and those who send their children in private school, benefit from.
College education, however, is far more of a private benefit.
The effects of having a populace that is largely illiterate, and one where there is a shortage of (for example) entomologists, are very different.
Ensuring basic literacy, which includes math and cultural/historical studies, universally (or near-universally) across society changes society in a positive way for everyone.
That degree in Medieval Sports? Not so much.
— Matthew G. SaroffPerhaps you’ve not heard of the Coverdell ESA? I believe that applies to any valid educational expense, which should include private school.
Admittedly, if you’re paying for private preschool, you don’t have a lot of time to get a tax advantage; but if your goal is to save for a private HS, it works. Then if you don’t use some of it, use it for college.
— Joe DAre 529’s that good?
When you open the account it is in the child’s name. Which means when you apply for Financial Aid, you will receive less aid. Money in the child’s name is to be spent on education at a much higher rate then money in the parents name. Is this offset by the tax breaks, or am I reading the set-up of the 529 wrong?
— Kurt529 plans are considered parental assets in the determination of financial aid and would not reduce the aid package any more or less than if the parents invested in mutual funds, bonds, a savings account or any other investment.
Additionally, the person who opens the account retains ownership of the account and can change the beneficiary of the account if the child does not attend college.
Coupled with the tax incentives, all of this makes 529 plans a very attractive vehicle for parents who are saving for college.
— ChrisThink public choice. Colleges lobbied hard for the various subsidies, which in form go to their students but in practice go largely to the schools. Private K-12 schools just haven’t been very effective lobbyists.
— Alan GunnTo Joe D - Not everyone can contribute to a Coverdell ESA. There are certain income thresholds that disqualify some individuals. I’m assuming anyone spending over $30,000 for grade school is in that income group that is disqualified.
To Kurt - 529s are normally set up as the parent as the owner and the child as a beneficiary. The asset is considered an asset of the parent normally, counting much less against financial aid.
— JeffKurt, I believe the 529 money is now treated as a parental asset, so while it does decrease financial aid eligibility, the impact isn’t that big.
Here’s some good information from SmartMoney: http://www.smartmoney.com/ask/index.cfm?story=20040128
And from the SEC: http://www.sec.gov/rss/your_money/529plan5.htm
— Mary@Kurt-
— BenAs I understand it, both 529’s and Coverdell ESA’s are not considered the beneficiary’s (child’s) funds for financial aid. Parent assets are only counted as 6% available for tuition, whild child’s assets are counted as 35% available.
Another tax insanity is the FICA withholding tax. Once you reach a certain income (currently $102,000) you STOP paying Medicaid and Medicare.
Now, I’m lucky enough to be above this limit, but even I can see this isn’t fair.
Michael
— Michael CoyleUmm, don’t public universities receive a non-trivial amount of government funding?
To comment directly on the tax question, the tax system in this country could be vastly simplified just by getting rid of all the subsidies, deductions, etc. I myself rent, contribute to my 401k and charity through an employer program so it is all included on my W-2, and my taxes took me five minutes. I didn’t really qualify for many deductions. The problem with simplifying the tax code is that there are many parties that happen to like the tax deductions that they qualify for, they just don’t like all the other deductions that they have to dig through. You can’t really find a deduction that doesn’t benefit at least one person (especially someone who contributes money to politics) who would not be too thrilled about the idea of having to pay more taxes.
If the current tax system wasn’t encumbered by all these deductions, subsidies, etc., then it wouldn’t be far from a flat tax, just more progressive. So people who advocate a flat tax surely have other reasons for thinking a flat tax is best that have nothing to do with the complexity of the tax code.
— Scott K#6 Kurt, you are correct. The FAFSA (Free Application for Federal Student Aid) formluas expect your kids to spend their cash first, then the parent’s cash. It penalizes those with cash savings (529’s)and other assets like stocks and mutual funds(except retirement plans and your primary home). This doesn’t hurt the super-wealthy (who have plenty) or the poor (who have none) - only those in the middle class.
— no-debt college parentI found a better strategy has been to liquidate mine/my kid’s cash (pay down my mortgage, put money into IRA/401Ks), and tell them to keep their grades up and hope for the best. So far, the financial aid for two kids has been enough to allow them to attend private college, and I can pay the balance of their tuition out of my regular earnings on a monthly payment plan. No loans so far.
You get a pretty hefty tax break for having a large (>6K lb) Truck/SUV, whether or not you actually use it for farming.
— Rich WilsonFree? Free!? C’mon you know better than that. Nothing is free, especially public schooling.
— mgrovesI think it’s a fallacy that there is no tax break for rental housing. The owner of the house gets a tax deduction for the interest and taxes he pays on the house. Since the rental market is competitive, this presumably reduces the rental fee and thus the real beneficiary is the occupant of the house.
— Bill BeanWhy don’t we subsidize K-12? Most places do. It’s called property taxes (and if you don’t think you pay them because you don’t own your home then you are not an economist). Since colleges essentially benefit from a number of municipalities even on the state level the property tax connection makes much less sense.
Now none of this is to say that the tax code isn’t incredibly screwed up. The problem is that a lot of the general rationale of the system has been carved out for very specific and obscure tax interests.
Also, to #12 FICA tax does not ’stop’ for Medicare at $102,000 of income. It is only for Social Security (aka OASDI taxes).
— chappySubsidizing K12 would make no difference in the number of people educated, nor improve quality.
Subsidizing college, however, increases the number of students and a large population of highly educated people spills over to all other tax payers as well.
— RobertTwo words: Teachers Unions.
Teachers Unions are dead set against any kind of free market competition and they are among the staunchest, and loudest, supporters of the Democrats. Any support for people being able to opt out of public schools will be over their dead bodies.
I disagree with the comment that subsidizing K-12 will make no difference in the number or quality of people graduating: many public schools have high drop out rates and abysmal standards. Anything that gets kids out of these schools will help on both counts.
— Robert L. www.neolibertarian.comThe tax-free growth provision of Coverdell ESAs (yes, these accounts can be used for K-12 expenses) expire at the end of 2010. For some reason Congress hasn’t made that provision permanent, while they did so for 529s. Indeed, the US tax code does seem arbitrary.
— Robin@Hantra
I am not sure what standards you are using to gauge the proportion of the population thst is being educated. According to the NAEP, neither public nor private schools in the US are producing proficiency in a majority of students. But thanks for the banal generalization.
— Chris#17 Rental housing does not get the same tax benefit as owner occupied housing does. Yes, they get to deduct interest and taxes, but so too do all businesses. Their income taxes are based on rent revenues minus expenses (interest, property taxes, depreciation, etc.) Homeowners get to deduct these expenses but don’t have to declare the “imputed rent” they get from using their house. To see this clearly, suppose that you and your neighbor decide to swap houses by each renting from the other, instead of buying from each other. Both of your taxes would rise, because now you would each have to declare the income of renting out your house.
— liberalarts“If, however, you choose to send your kids to private or parochial school, you are still paying school taxes for other people’s kids as well as the tuition for your own kids”
That’s not quite true. Public schools, at least the one where I’m from, divvy up the state’s pool of funds based on the number of students attending. If you put your kids in private school, that school loses a share of the state funding.
Incentives (or vouchers) for private K-12 schools are dumb because they give more money to the people who can afford them and take money away from those who cannot. They also won’t make private schooling more affordable: you’re an economist, what happens when the demand for something goes up but the supply stays the same?
— Ryan CannonA good column but it ends in a non sequitur. A flat tax has nothing to do with deductions. It is possible to abolish all or most deductions and still have a progressive tax.
— Richard Lachmann