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American families may contribute to tax-advantaged savings accounts known as 529 plans to save for a child’s college and graduate education. These plans have come under scrutiny in recent years as favoring upper-income households, who use them at much higher rates and derive a greater benefit from the tax savings therein. However, less scrutinized is the federal government’s student loan program, which offers student borrowers loan forgiveness after 20 years of payments. Due to changes lawmakers adopted in 2010, this program also has the potential to deliver sizable benefits to upper-income families.
In this report, we compare the fiscal costs of the 529 plan and the federal student loan program for a hypothetical upper-income family. We assume our household has the choice to finance $68,000 worth of expenses for a child’s undergraduate and graduate college education through a 529 college savings plan or through the federal student loan program. We find that when the upper-income family uses the loan program, it receives 1.5 to 2.3 times the magnitude of federal benefits versus using a 529 plan.
One of the main reasons for this difference is that the tax benefits of 529 plans are secondary and therefore practically limited; savers avoid tax only on distributed earnings, not on contributions. By contrast, the loan program offers potential forgiveness of both principal and interest, a benefit that even upper-income users can realize if they borrow to finance a graduate education. While 529 plans tend to favor more affluent families, the loan program can provide even larger benefits to these households, and policymakers may wish to address the costs of both programs, not only the former. In that regard, they could cap the amount graduate students can borrow through the loan program and restrict the tax preferences of 529 plans to only undergraduate educational expenses, disallowing them for graduate and professional educations.
Historically, the federal government’s higher education programs have been targeted to students from low-income families. The student loan program, created in the 1960s, provided benefits to only lower-income students, as did the Pell Grant program, which Congress established in the 1970s. But this philosophy changed in the 1990s. Lawmakers opened the loan program to all students regardless of income and created tuition tax credits for middle-class families. In the 2000s lawmakers went further, raising the income limits for the tax credits and making 529 college savings plans tax-free for families of all incomes.
Although both political parties have historically supported allowing upper-income families to claim tax breaks for college expenses, 529 savings plans have come under increasing scrutiny in recent years because they overwhelmingly benefit high earners.1 The most prominent attack on 529 plans occurred in 2015 when President Barack Obama called on Congress to eliminate this federal tax break. (The Obama administration quickly dropped the proposal after bipartisan opposition.)2
Lawmakers have also greatly expanded the benefits that upper-income families can receive through the federal student loan program in recent years, but the benefits this program now provides to upper-income households have escaped scrutiny. In 2010, Congress and President Obama expanded benefits under the Income-Based Repayment (IBR) program, which provides loan forgiveness after 20 years of payments. While IBR provides an important safety net for student borrowers who unexpectedly earn lower incomes when they leave school, the 2010 expansion also has the potential to provide benefits to upper-income families.
In this report, we analyze whether a 529 plan or the IBR program provides larger benefits to upper-income families. Specifically, we examine the potential benefits a hypothetical family and student would receive by financing an undergraduate and graduate education using a 529 plan or using IBR to repay federal student loans. We find that for a typical upper-income household, the loan program and IBR provide more than twice the benefits of a 529 plan.
Importantly, this brief does not provide a distributional analysis of the benefits of 529 plans and federal student loans. We are not able to assess how much total government subsidy each group of beneficiaries receives under IBR or 529 plans. As we discuss, 529 plans inevitably provide more in total government funds to upper-income families than to lower-income families. IBR, on the other hand, provides benefits to both groups and may even provide a disproportionate amount of government subsidies to lower-income families. However, our focus is on the magnitude of each program’s subsidy to upper-income families rather than the distribution of that subsidy among families of different income levels.
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