by Gordon Haave, Global Wealth Protection
(In the following essay I will show how a 529 plan is NOT a mechanism for saving money for a child’s tuition, but is in fact simply saving money for a college administrator’s salary)
With a four year college degree estimated to cost over $50,000, and rising every year, parents are scrambling to find a way to set aside money to pay for this looming expense.
One popular item is the 529 plan, named after section 529 of the IRS code. In short, a section 529 plan allows the money that you contribute to the plan to appreciate tax free on a federal level, with withdrawals also tax-free if used for qualified higher education expenses. Differing states have differing incentives as well. Sounds like a good deal, right? Only it isn’t.
In order to understand why 529 plans are a bad deal, one needs to understand the concept of price discrimination.
In terms of economic theory, price discrimination exists when sales of identical goods or services are transacted at different prices from the same supplier.
Let’s translate that into English and use an example: Let’s say you own a hamburger stand. You know that on any given day there are people who come into your burger shop who are not only wealthy but are hungry, and would gladly pay 7 dollars for a burger. Most however are middle income and are not that hungry, and therefore have time to choose where to buy lunch. They might only be willing to pay 5 dollars for a burger.
The problem for you as a supplier is that you don’t know which is which. So, you price your burgers at 5 dollars and a few lucky customers pay 5 dollars for a burger they would have gladly paid 7 dollars for.
Companies go to great lengths to price discriminate. In order to effectively price discriminate two conditions must be met: 1.) The firm must be able to identify the different market segments based upon their willingness to pay, and 2.) The firm must be able to enforce the price discrimination scheme.
The most common example of this is the airlines. The airlines know that business travelers are willing to pay more than leisure travelers. So they did market research and discovered that business travelers don’t like to spend the weekend away from home, and often buy their tickets at the last minutes, whereas leisure travelers plan ahead and usually stay on Saturday nights.
So, the airlines charge more if you don’t stay Saturday night, and if you don’t buy your tickets in advance (although the buy in advance pricing structure seems to be breaking down). The airlines enforce this scheme by making tickets non-transferable.
The most common price discrimination scheme is senior citizen discounts. Another way of saying “senior citizen discount” is “non senior citizen surcharge”.
Senior citizens are more price-sensitive than others in part because they have more time to price compare, and often because they are on fixed incomes.
So, a restaurant will charge a senior a price that reflects what seniors are willing to pay, and a higher price to others. The restaurant can enforce this by checking ID. Theoretically, a 35 year old could get around this by paying a senior to buy his meal for him, but the dollars involved are not enough to make that worthwhile.
Now that you understand price discrimination, let’s take a look at how college tuition works:
Customers approach a college. Some have more income and assets than others. So, how much should they charge? Wouldn’t it be nice if they could figure out EXACTLY how much you are willing to pay before you are quoted a price? Well, that is EXACTLY what they do.
Now, they can’t tell you that is what they are doing, so they quote a ridiculously high price, and then they say “but maybe we can give you a discount if provide us with all of your financial information. During the interview process they even figure out how badly you want to go to that particular school versus another. Only after they have figured out EXACTLY how much you are willing to pay do they actually tell you what the price is. For the very wealthy, the price is the ridiculously high price quoted. For others, it is that price paid over time because the federal government is happy to do you a favor and front that tuition for you (or back a bank that does), as long as you pay them back for much of your adult life (and of course you can’t discharge that debt in bankruptcy under almost all conditions). Others simply get quoted a lower price in the form of “grants”, while others still sign on for indentured servitude in the form of “work-study”. For many it’s a combination of the various schemes, all designed for one purpose: To figure out the max price that you are willing to pay, and to charge you that.
So where do 529 plans come in? As the price discrimination scheme has led to ever increasing prices (and thus ever increasing jobs and salaries for college administrators (insert link) , consumers have responded by trying to hide the amounts that they are able to pay. So the colleges, again aided by the federal government, invented the 529 plan. By getting you to put money in the 529 plan, when you approach a college and ask how much it will cost, they will immediately can say “whatever is in the 529 plan, plus whatever we would have charged you anyway”.
So you see, every single dollar you put in your 529 plan goes directly to a college administrator and not to your child.
What are some solutions to this problem? Tune into Global Escape Hatch and sign up below for the next in this series.