How to Encourage Families to Save for College

This month, as parents of college-age students sign promissory notes for student loans and watch tuition checks diminish their bank accounts, Congress is encouraging all parents to wake up and start planning. While National College Savings Month -- meant to spread awareness about the need to save for higher education -- has a laudable goal, promoting the importance of saving won't do much to help struggling families afford the cost of higher education.

The decline of home prices means that most families can no longer count on equity to finance their children's college costs. That loss, combined with rising food and fuel prices and stagnant wages, makes the idea of saving for college costs almost laughable, especially given that the average cost of tuition alone at a four-year public college already exceeds $6,000 a year (it's $24,000 at a private institution) -- a jump of 6.6 percent in just one year, far outpacing both inflation and, more important, growth in wages. If we really expect American families to make saving central to the financing of higher education, Congress needs to do more than designate a month of awareness. It needs to provide families with products and incentives to help them become successful savers.

In 2001, Congress took an important first step to help middle-class families save for higher education by creating Section 529 college-savings accounts. Money in those accounts grows tax-free and does not count as income if withdrawn to pay for qualified expenses at accredited postsecondary institutions. Although defined in federal law, 529 accounts are actually operated by individual states. Because there are no residence restrictions on enrollment, families have more than 50 plan options, with considerable variation in fee structure, investment performance, and financial incentives.

Despite a rapid increase in the use of 529 plans, from just $2-billion invested in 2001 to nearly $130-billion at the end of 2007, data that I've gathered from states suggest that the accounts are often used as tax shelters for wealthy families. But there are many ways that both state and federal policy makers can reform and expand 529 plans to make them more attractive to working families and make saving central to the financing of higher education.

First, state governments must better regulate fees charged by 529-plan operators. A 2008 study by savingforcollege.com found that total fees over 10 years for some 529 plans reach more than $2,600. And that includes only "direct sold" plans, administered directly by states; fees charged to families who open accounts through brokers can be considerably higher. Those costs quickly eat away at the hard-earned and carefully saved money of working families.

Federal policy makers must restrict the fees that can be charged on basic 529 accounts, and aggressively rein in predatory brokers who provide little additional benefit to families, at considerable additional cost. What's more, state policy makers should consider following the lead of Utah and Louisiana and waive administration fees for all state residents. Alternatively, states could waive fees for lowand moderate-income families and use revenue generated from fees collected on wealthier account holders to help pay for other progressive measures.

Second, if we expect families to save for higher education as they do for retirement, we must offer incentives. Just as the federal government provides more than $100-billion a year in tax breaks for deposits in 401(k) and IRA accounts, all states should make contributions to 529 accounts deductible for state-income-tax purposes. And the Saver's Credit, a federal tax credit for contributions made to retirement-savings accounts by lowand middle-income families, should be extended to include contributions made to 529 accounts, a proposal championed by both Democrats and Republicans, including President Bush.

State and federal policy makers should also provide specific incentives to encourage saving among lowand middle-income families. More states should start by offering direct matches of deposits made by families below the area median income, as 11 states already do. At the federal level, Sen. Robert Menendez, a Democrat from New Jersey, recently introduced an innovative bill to create a "saver's bonus," which would match deposits made by low-income families in qualified savings vehicles, including 529s.

To give families the jump-start they need, state and federal policy makers should also consider seeding accounts with initial deposits. Oklahoma is leading the way with its SEED OK program, which established 529 accounts -- each starting with $1,000 -- for 1,360 randomly selected babies born in the state. Giving all American children accounts would have the immediate, profound effect of setting a national expectation of postsecondary education for every child by offering families a way to save for the future.

What's more, school systems in cities including New York, Baltimore, Atlanta, and Washington, which are experimenting with "pay for performance" programs, could use 529s as a platform to reward and invest in students. Instead of simply cutting them checks for earning good grades, school systems could deposit some of those funds directly into 529 accounts to help those students continue their education. By directing a portion of those reward payments into 529 accounts, officials would promote a message of achievement and help low-income students afford college.

Where would the money come from to pay for the cost of seeding accounts, matching deposits, and expanding the use of 529 accounts among lowand moderate-income families? To start, Congress could redirect the poorly targeted Hope and Lifetime Learning credits into block grants for states to progressively support their 529s and experiment with new incentives -- a move that would free up $6-billion to $8-billion a year.

Federal and state policy makers should use National College Savings Month as an opportunity to enact common-sense policies to reform and expand 529 plans and help American families save for higher education. Smart policy will surely do more to draw awareness -- and increase saving -- than will pamphlets, news releases, and symbolic legislation.