In a tax overhaul as sweeping as the one Republicans hope to pass before the end of the year, there are bound to be provisions whose full effects won’t be clear right away.
But I’m comfortable predicting that a proposed change to 529 savings plans would have negative unintended consequences. That’s because it is setting up a rerun of a story we’ve seen play out before: the soaring price of college tuition.
A Section 529 savings plan is a vehicle that allows tax-advantaged saving for college costs. Withdrawals for qualified expenses such as tuition, fees, books and supplies are tax-free, and account owners can change the beneficiary relatively easily. If your older child gets a full-ride scholarship to the school of her choice, you can change the plan beneficiary to her younger sister, for example.
Until now, qualified expenses were limited to those associated with attending eligible postsecondary institutions. Any earnings from nonqualified withdrawals are taxed as ordinary income, plus a 10 percent tax penalty. But a provision that appeared in both the House and Senate tax reform bills, with slightly different details, would expand the definition of a qualified expense.
Sen. Ted Cruz, R-Texas, proposed the amendment to the Senate bill that would expand 529 plans to cover expenses at private K-12 schools, as well as certain home-school expenses. The House bill included a similar expansion, though its version did not include home schooling. Precisely which private schools will qualify, Cruz suggested, will be up to the states running the 529 programs in question. (Currently, colleges and universities must be accredited or recognized by the Department of Education to be eligible for 529 money.)
On its face, this adjustment might seem like a good thing. If saving for college is worthwhile, why not encourage saving for K-12 education the same way?
The problem is the bigger picture. If the government effectively subsidizes private schools, the price of tuition is bound to inflate artificially relative to what parents would otherwise pay. In other words, private elementary and high schools will enter the same inflationary spiral we’ve seen with colleges.
If using 529 plans to fund private elementary and secondary education succeeds, demand for these schools will rise, since parents will be able to consider private school when they otherwise wouldn’t, or perhaps consider a higher-priced school than they normally would. As demand rises, tuitions are likely to rise too. In order to sell those increases to parents, schools will likely feel pressure to expand their faculty, build shiny new athletic facilities and spend on a host of other amenities – all of which will drive tuition even higher. And, much like colleges, private schools often sell a high sticker price as a sign of prestige, disincentivizing schools to keep costs down when they can offer scholarships or other discounts to the sticker price instead.
The Coverdell Education Savings Account already allows savers to pay for education at any level. But it has not had the sort of effect I’m describing because it is a much narrower plan. Coverdells have much lower contribution limits (the maximum allowable contribution for 2017 is $2,000) and are not open to Americans above a certain income threshold.
If today’s private schools are doing good work, great. Leave them to it. And if they’re struggling, allow nature to run its course. The best schools will survive and be able to charge what the market will bear, while the worst schools will disappear.
In theory, the point of using the tax code to favor a choice is to encourage more people to make that choice. But subsidizing private schools and artificially inflating their tuition does not strike me as helpful – not to the kids who attend, the parents who pay or kids who might have attended before tuition climbed out of reach. Private schools and parents who wouldn’t think of sending their children to public school would stand to benefit, while public schools (where 90 percent of U.S. students attend) would not.
Making sure kids get a great education is worthwhile. But this is not the way to go about it.
Posted by Paul Jacobs, CFP®, EA
Sen. Ted Cruz. Photo by Gage Skidmore.
In a tax overhaul as sweeping as the one Republicans hope to pass before the end of the year, there are bound to be provisions whose full effects won’t be clear right away.
But I’m comfortable predicting that a proposed change to 529 savings plans would have negative unintended consequences. That’s because it is setting up a rerun of a story we’ve seen play out before: the soaring price of college tuition.
A Section 529 savings plan is a vehicle that allows tax-advantaged saving for college costs. Withdrawals for qualified expenses such as tuition, fees, books and supplies are tax-free, and account owners can change the beneficiary relatively easily. If your older child gets a full-ride scholarship to the school of her choice, you can change the plan beneficiary to her younger sister, for example.
Until now, qualified expenses were limited to those associated with attending eligible postsecondary institutions. Any earnings from nonqualified withdrawals are taxed as ordinary income, plus a 10 percent tax penalty. But a provision that appeared in both the House and Senate tax reform bills, with slightly different details, would expand the definition of a qualified expense.
Sen. Ted Cruz, R-Texas, proposed the amendment to the Senate bill that would expand 529 plans to cover expenses at private K-12 schools, as well as certain home-school expenses. The House bill included a similar expansion, though its version did not include home schooling. Precisely which private schools will qualify, Cruz suggested, will be up to the states running the 529 programs in question. (Currently, colleges and universities must be accredited or recognized by the Department of Education to be eligible for 529 money.)
On its face, this adjustment might seem like a good thing. If saving for college is worthwhile, why not encourage saving for K-12 education the same way?
The problem is the bigger picture. If the government effectively subsidizes private schools, the price of tuition is bound to inflate artificially relative to what parents would otherwise pay. In other words, private elementary and high schools will enter the same inflationary spiral we’ve seen with colleges.
If using 529 plans to fund private elementary and secondary education succeeds, demand for these schools will rise, since parents will be able to consider private school when they otherwise wouldn’t, or perhaps consider a higher-priced school than they normally would. As demand rises, tuitions are likely to rise too. In order to sell those increases to parents, schools will likely feel pressure to expand their faculty, build shiny new athletic facilities and spend on a host of other amenities – all of which will drive tuition even higher. And, much like colleges, private schools often sell a high sticker price as a sign of prestige, disincentivizing schools to keep costs down when they can offer scholarships or other discounts to the sticker price instead.
The Coverdell Education Savings Account already allows savers to pay for education at any level. But it has not had the sort of effect I’m describing because it is a much narrower plan. Coverdells have much lower contribution limits (the maximum allowable contribution for 2017 is $2,000) and are not open to Americans above a certain income threshold.
If today’s private schools are doing good work, great. Leave them to it. And if they’re struggling, allow nature to run its course. The best schools will survive and be able to charge what the market will bear, while the worst schools will disappear.
In theory, the point of using the tax code to favor a choice is to encourage more people to make that choice. But subsidizing private schools and artificially inflating their tuition does not strike me as helpful – not to the kids who attend, the parents who pay or kids who might have attended before tuition climbed out of reach. Private schools and parents who wouldn’t think of sending their children to public school would stand to benefit, while public schools (where 90 percent of U.S. students attend) would not.
Making sure kids get a great education is worthwhile. But this is not the way to go about it.
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