Saving for college may result in future losses, report says

Black Issues in Higher Education, Oct 7, 2004 by Kathleen Kennedy Manzo

Pinching pennies early for college and investing in state-sponsored savings plans actually result in a net loss for students, considering the financial aid reductions that may result, particularly for low-income students who plan to attend community colleges, a new report concludes.

Money in the bank can reduce need-based aid, dollar for dollar, especially at two-year institutions, where tuition is relatively low, according to the report, "When Saving Means Losing: Weighing the Benefits of College-Savings Plans," released recently by the Lumina Foundation.

Economists Roberto M. Ifill and Michael S. McPherson analyzed the interplay between the savings plans, now available in all 50 states, and need-based aid programs. "As family incomes rise, families in effect 'top out' of the needs analysis system," they write. "This happens quickly at low-cost institutions such as community colleges where even middle-income families are unlikely to be eligible for aid."

The Indianapolis-based Lumina Foundation promotes efforts to improve access to higher education, through research, grants and other programs. Ifill, a former research fellow at the American Council on Education, is an independent consultant based in Washington, D.C. McPherson is president of the Spencer Foundation in Chicago.

In the past two decades, college savings plans have been rolled out--or are about to be--by all the states to much fanfare, and recent tax laws have provided incentives for participating. Earnings and withdrawals on the plans are free of federal taxes through at least 2010. The programs have been marketed heavily in some places, urging parents to begin contributing even while their children are still infants.

The promotional materials generally tout the plans as a painless way to save for universities and community colleges, but they do not outline as diligently the potential financial drawbacks. In fact an outline of the plans from The College Board states that they have a low impact on financial aid. The savings plans even are encumbered by some risk of loss, depending on various market factors. Plans in many states, for example, suffered losses several years ago due to stock market fluctuations.

Since financial aid decisions are based on a student's other resources, savings are generally counted against any federal or state aid that could be awarded. Such formulas can create a disincentive for savings for students at the lower income range, the Lumina report concludes.

About 6 percent of the value of the savings is counted toward the expected family contribution toward college costs, according to the New York City-based College Board, which administers the SAT college entrance examination program.

The report says the savings plans can be beneficial when the money is used for tuition at four-year institutions, where much higher costs lessen the impact of savings in financial aid formulas.

The proportion of community college students who have saved through the so-called "529 plans" is relatively low. Indeed, while most Americans say they favor tax incentives for college savings plans, only about a third of parents have invested in such programs, according to a recent survey by Fidelity Investments. Some parents and students, however, enroll in such programs with the intention of using the money at four-year colleges, only to decide years later on the community college option.

The latest report suggests caution to those weighing their savings decisions.

"Saving for college has never been easier, thanks to many good state and federal programs," said Martha D. Lamkin, president and CEO of the 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."

Such decisions should be made with additional care by those with limited income, as well as those who anticipate that they or their children will pursue a degree first through a two-year institution, said Betty L. Davis, the dean of enrollment management at the Community College of Allegheny County in Pittsburgh and an officer with the National Association of Student Financial Aid Administrators.

"We encourage savings. The community college shouldn't be the choice because a family has no savings for college," she said. "But I always thought that the intent of these savings plans was not for the community college student ... because we're so affordable."

Students intent on attending a two-year college, she said, should instead pursue financial aid options when the tuition is out of their reach. "I think about a really poor family and they have nothing disposable to put away, and if they do, it is not intended for education purposes," she said. "But there are ways we can help them. That's a part of what we do."

The report is available at <www.luminafoundation.org>.