February 21, 2013
By: Gordon Haave
A 529 Savings Plan is NOT a mechanism for saving for a child’s college tuition, but rather saving for a college administrator’s salary.
With a four-year degree estimated at $150,000 or more – and rising every year – parents scramble to find a way to pay for this looming expense. One popular product is the 529 Savings Plan, named after Section 529 of the IRS code. In short, a 529 Plan allows the money you contribute to appreciate tax free on a federal level, with tax-free withdrawals if used for qualified higher education expenses and incentives varying from state to state. Sounds like a good deal, right? Well, it isn’t.
To understand why 529 Plans are bad, one needs to understand the concept of price discrimination. In economic theory, price discrimination exists when sales of identical goods or services are offered at different prices from the same supplier.
For example: Let’s say you own a hamburger stand. You know on any given day some who come into your burger shop are not only wealthy but hungry, and would gladly pay $7 for a burger. Most, however, are middle income and not that hungry, affording them more time to choose where to buy lunch. They might only be willing to pay $5 for a burger.
The problem as a supplier is you don’t know which is which. So, you price your burgers at 5 dollars, and a few lucky customers pay a few dollars less than what they were willing to for a burger. In this case, you would LIKE to price discriminate, but can’t. In order to effectively price discriminate, the supplier must meet two criteria: 1. ability to identify the different market segments based upon their willingness to pay, and 2. ability to enforce the price discrimination scheme.
A common example of this is the airlines. Airlines know business travelers will pay more than leisure travelers. After some market research, they discovered business travelers don’t like spending weekends away from home, and often buy tickets at the last minute; whereas, leisure travelers plan ahead and usually stay on Saturday nights. They identified the market segments by identifying their purchase habits. So, airlines charge more if you don’t stay Saturday night and don’t buy your tickets in advance (although the buy-in-advance pricing seems to be breaking down). They enforce this scheme by making tickets non-transferable.
Another common price discrimination scheme is senior discounts, or otherwise read as “non-senior surcharge”. Senior citizens are more price-sensitive, in part because they have more time to compare prices, but also because many live on fixed incomes. So, restaurants charge seniors a price reflecting what they are willing to pay, and a higher price to others. The restaurant enforces this by checking ID. While this masquerades as an acceptable form of age discrimination, it is, in fact, purely price discrimination designed to maximize profits.
With what we know about price discrimination, let’s look at how college tuition works:
Customers approach a college, some with more income and assets than others. How much should colleges charge? Wouldn’t it be nice if they could figure out EXACTLY how much you are willing to pay before quoting you a price? Well, that is EXACTLY what they do.
They won’t say they are profiling you, so instead they quote a ridiculously high price, and then say “but maybe we can give you a discount if you provide all of your financial information.” During the interview process, they even figure out how much you want to attend that particular school versus any other. Only after they deduce 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 one. For others, it is that price paid over time, because the federal government is happy to front that tuition for you (or back a bank that will), as long as you pay them back. So for much of your adult life, your finances revolve around this debt. And of course, you can’t discharge that debt even in bankruptcy under almost any circumstances. Some receive a lower price in the form of “grants”, while others sign on for indentured servitude in the form of “work-study”. For many, it’s a combination of those things, all designed for one purpose: to figure out the maximum price you will pay, and charge that.
So where do 529 Plans come in?
Over the last few decades, colleges perfected price discrimination by lobbying the government to loan you money. This ensures you can pay more each year. As tuition got out of control, consumers, at some level, understood what was happening and shielded their assets before applying for financial aid.
So, the colleges, again aided by the federal government, invented the 529 Plan. By getting you to put money in a 529 Plan, when you approach a college and ask how much it costs, they immediately say “whatever is in the 529 Plan, plus whatever we think you are willing to pay”.
With skyrocketing college costs, where has all this money gone? To new classrooms? To better professors? Of course not. It went entirely to a boom in the numbers and cost of college administrators. Now that you know where the money comes from, here’s where it goes.
To recap: Colleges mastered the art of knowing exactly how much you, individually, can pay, and that is what they charge you. They lobby the federal government to loan you money, so you can pay even more. And now, to keep you from hiding your assets and saving your money, they invented the 529 Plan. Where does all this extra money go? Into the pockets of college administrators. Hence, every dime put into a 529 Plan is not for the benefit of your children, but for the benefit of a college administrator.
Formerly the Chief Investment Officer of a $4 Billion dollar trust company and consulting group, Gordon Haave is the President of Global Secured Investments. He currently resides in Panama City, Panama.