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Why Are Families Leaving $237 Billion on the Table?

Our new study shows that by using 529 plans to their fullest, the average family would have over $4,000 more to pay for college.

This week, Morningstar released our annual ratings of 529 college savings plans showing the best among 62 options.

We've also done something new with this round of ratings. We added a detailed analysis of what would happen if American households used 529s to their fullest. The results were quite surprising. We estimate that American families leave over $200 billion on the table by not using 529s for college savings. We've published the full analysis in our new report, New Lessons About 529s, which you can download here.

The Analysis In the report, we examined the finances of actual American households using two nationally representative surveys: the Federal Reserve Bank's Survey of Consumer Finances and the Sallie Mae/Ipsos survey, How America Saves for College.

For each household with children younger than 18, we simulated two scenarios. First, we forecast the total education savings each family would have by the time their children turned 18. In this simulation, families continued to save at the same rate, using the same vehicles they had used thus far.

In the second scenario, we examined what would happen if families had used 529s exclusively for their college savings, from the day each child was born until the child turned 18. Those savings would be invested along a standard glide path that decreased stock exposure as the child approached college age.

In addition, we also conducted a novel experiment. If 529s are beneficial, how could policymakers and advisors increase their usage? We tested three ways of presenting information about 529s to a panel of American parents with children younger than 18 (using the Prolific online research platform) to determine if any of the presentations would change people's planned 2019 529 contributions.

The High Cost of Inaction We estimate that by the time children are ready for college, American households would collectively have $237 billion more in assets if they had used 529 plans exclusively. For the average family saving for college, this means $4,044 more per child without saving an additional penny. To consider this potential boon from another angle, families could save 25% less and still have the same amount available when their child is ready for college.

What drives this effect? The largest driver is not the tax incentives that 529s are known for. Many families put their college funds in savings accounts and do not invest it. Since 529s are primarily investment vehicles, they can help families earn a much higher return over time. The tax advantages of 529s do help, but they have a smaller impact.

Here is what each aspect of 529s contributes:

  • Unused state tax benefits: $26 billion
  • Unused capital gains tax benefits: $50 billion
  • The (post-tax) benefit of investing college savings: $161 billion

The benefit of investing is not unique to 529 accounts; any investment vehicle would provide it. Tax incentives from 529 plans, although smaller, do matter. They account for roughly one third of the total benefit, with a particular boost coming from the capital gains incentive.

We found that 529 contributions would increase (by more than 10%) relative to a randomly assigned control group information about 529s was presented more clearly--a notable impact for such a small change.

What Does That Mean for a Particular Family? Within these aggregate numbers, there is a great deal of diversity. For a given family, here are four questions to ask to better understand their specific effect:

  • Are you saving for college at all? If not, that's OK, and there can be very good reasons (like prioritizing saving for retirement). The rest of this analysis just isn't relevant to you, however.
  • Are you investing those funds? If you leave it in checking or savings accounts, like many Americans do, you are likely making it harder on yourself and your family. In our analysis, that is the single most important aspect of 529s: They encourage families to invest college savings.
  • Are you comfortable taking on investment risk? A thoughtfully chosen investment, especially one that decreases volatility over time as your child's time for college approaches can give a significant boost to your savings, while decreasing investment risk, but it can't eliminate it altogether.
  • Have you carefully reviewed the options for 529s? There is actually quite a range of plans in terms of fees, performance, and lineup of options. On their own, these options can be overwhelming. Morningstar can make this process easier with a straightforward medalist rating: Gold, Silver, and Bronze. You can check out those ratings here.

What Lessons Can We Draw? Focus on investing first, not byzantine state-by-state rules. Despite considerable discussion in the field about the annoyances and complexities of variations in state-by-state deductions, that is not the most important part of 529s; investing and capital gains incentives are.

Personalized advice is needed. In the end, the right choice for a particular family depends on their specific financial circumstances and preferences, especially about whether the rewards of investing one's college savings are worth the rewards. In other words, personalized analysis and advice is essential. We can help families evaluate these choices.

The results of our experiment show how 529s are presented does matter, and a clearer presentation can significantly increase usage, where appropriate.

This paper and article are part of the Investor Success Project. Learn more about it here.

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About the Author

Steve Wendel

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Steve Wendel is head of behavioral science for Morningstar, where he leads a team of behavioral scientists and practitioners who conduct original research to help people invest and manage their money more effectively. Before assuming his current role in 2015, he was principal scientist for HelloWallet, a company that specializes in web and mobile financial wellness programs, where he studied savings behavior and coordinated the research efforts of HelloWallet’s advisory board. Morningstar owned HelloWallet from 2014 to 2017.

His latest book, Improving Employee Benefits, shows HR practitioners how they can use behavioral economics to help employees to take action on their benefits. In 2013, he published Designing for Behavior Change, which describes HelloWallet’s step-by-step approach to applying behavioral economics and psychology to product design.

Wendel holds a bachelor’s degree from the University of California, Berkeley, a master’s degree from The Johns Hopkins University School of Advanced International Studies, and a doctorate from the University of Maryland, where he analyzed the dynamics of behavioral change over time.

Wendel is also the founder of the Action Design Network, a nonprofit organization that teaches members how use behavioral economics and psychology in product design. The network hosts more than 5,000 behavioral practitioners at events around the country, including the annual Design for Action Conference. Follow Steve on Twitter: @sawendel

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