Include 529 plans as an Eligible Product for the Saver’s Credit, and Make the Credit Refundable
Currently, taxpayers aged 18 years or older who are not dependents or full-time students may receive a nonrefundable Saver’s Credit equal to between 10 and 50 percent of their compensation up to $2,000 contributed to an employer-sponsored qualified retirement plan or IRA. Qualified contributions are reduced by distributions from qualified plans and IRAs during the current tax year, up to the due date of the return, including extensions. The Obama Administration has proposed that the credit become refundable and be modified such that the match rate would be 50 percent (up to $500) on qualified savings per individual per year.
Contributions to 529 plans are currently not eligible for the credit, but this would be accomplished by a bill currently in Congress, the Savings Enhancement for Education in College Act (HR 1351). In addition, including 529s in the Saver’s Credit was a piece of the New Saver’s Act (SB 1967) in the 110th Congress. The result of these two proposals would be an increase in the number of low-income families who enroll in and contribute to college savings accounts.
Create a Federal Employer Tax Credit for 529 Plans
Given all its advantages, the workplace is an excellent platform for facilitating greater college savings. This could be leveraged by providing a small tax credit to employers to offset the cost of facilitating participation in a 529 plan for employees and their families, as well as potentially matching employee contributions.
A similar tax credit exists to help employers set up qualified retirement plans for their employees. The credit covers half of the necessary costs of starting a plan, up to an annual maximum of $500 for the first three years of the plan. A tax credit for opening and matching contributions in 529 plans could encourage employers, particularly smaller employers, to help their workers start saving for college. There is also potential for employers to facilitate automatic enrollment in 529 plans, as many currently do with 401ks.
Redirect and Make Refundable the Higher Education Tax Credits
Because the Hope and Lifetime Learning tax credits are not refundable, many low- and moderate-income families with no tax liability are ineligible. In addition, families can wait up to a year and half before receiving the credits, instead of when tuition bills are due. Last year the American Opportunity Tax Credit was introduced as a temporary and partially refundable replacement for the Hope Scholarship as part of the American Recovery and Reinvestment Act. This new tax credit is partially refundable, thus making more low- and moderate-income families eligible, and it applies to books and supplies as well as tuition and fees. The Obama administration proposed making the American Opportunity Tax Credit permanent as part of its FY 2010 budget.
Addressing the current downsides of the credits, and delivering them earlier through college savings plans, would not only ensure that college funds are available when needed, but also allow them to grow over time and have a potentially positive impact on the behavior and expectations of low-income families.
Allow 529s to be Opened on Federal Income Tax Forms
Each year millions of Americans have their federal income tax refunds deposited electronically into some type of bank or investment account. Since 2007, tax filers have also had the option to split their refund and having it deposited in up to three different accounts. This has allowed them to easily save some of their refund at tax time without having to commit to saving all of it. The information required for such deposits includes the account number, the routing number for the financial institution, and whether the financial institution classifies the account as a checking or savings account.
Tax filers can make deposits into existing 529 accounts that have routing numbers, but those who have not opened a 529 before filing their taxes cannot. Allowing these taxpayers to open a 529 at tax time, directly on their federal income tax forms, would remedy this problem.
Financial Aid Reforms
Exempt College Savings and Assets from Federal Financial Aid Calculations
Under current federal financial aid rules, families who save for college can be penalized by receiving slightly reduced federal financial aid packages. The rules for savings in 529s are complex, but since parents are typically the account owners for 529s versus their children, a maximum of 5.64 percent of assets in 529s is used in assessing a family’s eligibility for aid. However, the mere knowledge that savings could potentially hurt their chances of receiving aid, along with the complexity of the current asset rules, has led many families to perceive college savings as a barrier to receiving aid and thus can discourage them from saving at all despite its many benefits.
The Student Aid and Fiscal Responsibility Act of 2009 (HR 3221), included a provision that would eliminate asset questions from the FAFSA, though these changes were not included in the Health Care and Education Affordability Reconciliation Act of 2010. In this proposal, a family’s college savings would not negatively affect their ability to receive need-based federal student financial aid, unless they have over $150,000 in assets. Families with assets in excess of $150,000 would not be eligible for need-based aid. Additionally, the Obama administration proposed simplifying the financial aid process in its FY2011 budget further by using IRS data to determine the expected family contribution.
Create a College Access and Completion Innovation Fund
The Student Aid and Fiscal Responsibility Act (HR 3221) created the College Access and Completion Fund (as also proposed in the Obama Administration’s FY2011 Budget), though it was not included in the Health Care and Education Affordability Reconciliation Act of 2010. The CACF would make grants to States, institutions of higher education, and other organizations to support innovative strategies that increase the number and percentage of students entering and completing college. Since 529 plans are sponsored by state governments, most innovations occur at the state and local level. Given the current strain on state budgets, federal incentive monies could be used to enact and enhance inclusive savings reforms. This program would cost $3.5 billion over 5 years.
The College Savings Initiative
The College Savings Initiative was launched in 2009 as a joint venture of the New America Foundation and the Center for Social Development (CSD) at Washington University in St. Louis. The Initiative is centered on developing and advancing progressive 529 college savings plans at the state and federal levels. It seeks to achieve this through study and promotion of existing progressive state-based 529 plans; modernization of existing federal college aid programs, including federal income tax-based aid programs; policy research and design; communications; and policymaker education. Ultimately, the Initiative aims to increase post-secondary education access and completion rates among lower-income, disadvantaged students through innovative public policy and other reforms to 529 college savings plans.
For background information on 529 college savings plans or the College Savings Initiative please go to http://collegesavingsinitiative.org
Read the entire research paper here.