News Release

FOR IMMEDIATE RELEASE
August 23, 2004

Lumina Foundation research reveals unplanned consequences of college savings plans

Indianapolis — Saving for college is always wise. But a new report from Lumina Foundation for Education cautions that families who save in certain state-sponsored college savings plans should be aware of the tax and financial-aid consequences of each program.

“Saving for college has never been easier, thanks to many good state and federal programs,” said Martha D. Lamkin, president and CEO of Indianapolis-based Lumina Foundation. "Middle-income families who appear to be in the best position to receive the benefit from these plans should carefully assess these savings options and their potential impact on need-based aid."

The report, When Saving Means Losing: Weighing the Benefits of College-savings Plans (PDF), resulted from a study that examined the interactions between college-savings programs and the need-based financial aid system. Economists Roberto M. Ifill and Michael S. McPherson conducted the study.

Since the early 1980s, state and federal governments have instituted numerous programs that encourage families to save for college. States created prepaid tuition plans and qualified state tuition plans ("529" plans), and Congress passed tax cuts that enhanced the tax benefits of these plans. Federal lawmakers also enacted federal tax credits for the Hope Scholarship, Lifetime Learning Program, and Coverdell Education Savings Accounts.

But according to the report, family funds invested in any one of a variety of savings plans, including standard bank savings accounts, can have varied tax and financial aid implications for families in different income groups. The report’s findings include:

Unlike wealthy families, low-income families have a financial disincentive to save for college: By saving, poorer families may reduce their eligibility for need-based grant aid as determined by the need-analysis system.
Depending on the formula used by a college in determining a student’s financial aid eligibility, an increase in savings in a 529 plan may result in a dollar-for-dollar decrease in eligibility for scholarships, grants and loans.
The college savings plans can reduce need by widely varying amounts, depending on which savings instrument a family chooses and what the family income is.
Families expecting to receive need-based aid would do better to invest in savings plans than in prepaid tuition plans. (The financial aid need-analysis system treats money in pre-paid tuition plans as being readily available for college payment; these funds thus reduce need dollar for dollar.)
The highest-income families – those with sufficient assets to be outside the need-based aid system altogether – are least likely to be influenced in their savings decisions by tax subsidies.
If the government intends to target federal tax subsidies to encourage increased college savings by those who find it harder to save and are most in need of help, efforts should be made to direct those subsidies more effectively to help lower-income families.

"An important message in our work is that differences that seem minor in terms of the goals of families who are trying to save can mean big differences in results," said McPherson. "For example, prepaid plans get very different financial aid treatment from savings plans even though the main purpose is the same. The lesson for consumers is to pay close attention and get good advice; the lesson for colleges and governments is to do all they can to eliminate these complications."

"It is clear that more research is needed on the issue to help guide public officials to address the unintended penalties that exist in the current system," said Lamkin.

About the authors
Roberto M. Ifill is an independent consultant on higher education in Washington, D.C. Previously, he was a Research Fellow at the American Council on Education and served on the senior staff at Macalester College and at Connecticult College.

Michael S. McPherson is president of the Spencer Foundation in Chicago. Previously, he was president of Macalester College and before that was the dean of faculty and a member of the economics department at Williams College.

Lumina Foundation for Education, a private, independent foundation, strives to help people achieve their potential by expanding access and success in education beyond high school. Through research, grants for innovative programs and communication initiatives, Lumina Foundation addresses issues surrounding access and success — particularly among underserved student groups, including students 25 years of age and older . The Foundation bases its mission on the belief that postsecondary education remains one of the most beneficial investments that individuals can make in themselves and that society can make in its people.