ST. PAUL — In 2011, as part of the deal to end a state government shutdown, Minnesota lawmakers eliminated a little-used matching grant that helped low- and moderate-income families save for college.
Six years later, the Legislature enacted a new set of college-savings incentives that are among the most generous in the nation — and which overwhelmingly benefit the affluent.
At an annual cost to the state of about $10 million, the incentives promote investing in a 529 plan, a federally authorized investment vehicle that allows families to grow their college-savings accounts tax-free.
Still unknown to most Americans, 529s largely benefit the wealthy because they’re the ones with substantial money to save for college, and because investment income is taxed differently from earned income: For federal income tax purposes, a 529 plan doesn’t benefit a married couple making less than about $100,000 because they can invest for their kid’s education tax-free in a regular brokerage account.
The Brookings Institution, a nonpartisan think tank, called 529s a “handout to the affluent” and “a strong contender for the prize of most absurd tax break of all.”
State tax incentives like the ones Minnesota passed in 2017 are similarly “wasteful” and “regressive,” according to their 2017 report, “A tax break for ‘Dream Hoarders.’ ”
Although Minnesota’s 529 plan tax incentives can help lower-income people who don’t benefit from the federal tax provisions, those families aren’t taking advantage the way higher earners are.
According to tax data the Minnesota Department of Revenue provided to the Pioneer Press:
•In 2017, the first year the state’s college-savings incentives were in effect, Minnesota tax filers with adjusted gross incomes over $100,000 were 46 times as likely as those making under $50,000 to claim a state tax benefit for contributing to a 529 plan.
•Those same high earners were five times as likely to claim a 529 plan tax break compared with filers making $50,000 to $100,000.
•Put another way, 79 percent of all claims for a 529 plan tax break came from the 22 percent of Minnesota tax filers who have adjusted gross incomes over $100,000.
Whether that’s a problem or not depends on who you ask.
“This has been a great success story,” said Rep. Greg Davids, R-Preston, who sponsored the 2017 bill and reviewed the tax data at the newspaper’s request.
Davids, who works as a financial planner, said college costs are too high, and he wants to reward families for taking the initiative to save up.
“I think we should help these folks,” he said. “My intention was to be very aggressive on this.”
Senate Tax Committee Chairman Roger Chamberlain, R-Lino Lakes, said that at $10 million a year — less than one-thousandth of the state’s income tax revenue — it’s “not a big deal” that the 529 incentives mainly help high earners. And he notes the government already does plenty for low-income students.
Minnesota ranks 11th in the nation in total need-based aid it awards to college students.
In 2018, the state handed out $194 million in state grants intended for students struggling to pay for college — although $7 million of that went to students from families making over $100,000.
The federal Pell Grant in 2018 delivered Minnesota students another $425 million.
Chamberlain points to the so-called “doughnut hole” of middle-income families who can’t write a check to pay for college but who qualify for little to no financial aid.
“We’re just trying to provide something for those folks in that gap,” he said.
Missed the mark
A survey by Sallie Mae and Ipsos found that among high-income people, half of what they were saving for college was locked away in either a 529 or a similar vehicle that was designed specifically for college savings.
That was true of just 9 percent of the dollars low-income people had saved for college.
The state’s 2017 tax breaks aimed to change that, said Sen. Greg Clausen, DFL-Apple Valley. He tried for years to enact state income tax incentives for 529 contributions before carrying the successful 2017 legislation in the Senate.
“The goal was to put 529 types of investment options in reach for more income levels, not just for the rich,” he said.
Clausen acknowledges the law missed the mark.
“I think it’s something to look at, definitely,” he said. “The statistics on it are rather interesting.”
The Minnesota Department of Revenue, too, was surprised by how the tax breaks have skewed toward high earners.
The department estimated the nonrefundable tax credit — available to low- and middle-income filers but not those at the very bottom who pay no taxes — would cost the state $7.5 million in 2017-18.
They figured the tax subtraction, available to all filers but especially advantageous for high earners, was estimated to cost $2.5 million.
In fact, the tax credit that year cost $5.4 million and the subtraction around $4.4 million.
Rep. Laurie Pryor, DFL-Minnetonka, vice chair of the higher education finance committee, said the incentives aren’t working as intended.
“The idea is to help make college affordable, and if we’re not reaching that group that needs the help, then it’s something that we need to take a look at,” she said.
How it works
Here’s how the 529 plan and tax incentives work:
• 529 plans are authorized by the federal government but operated by states, which offer varying fees and options for investing in stocks, bonds and the like. As long as the money is spent on college-related costs, the earnings are not taxed; earnings not spent on higher education are taxed as income plus a 10 percent penalty.
• Congress in 2017 made K-12 private school tuition an eligible expenditure for the 529 plan’s federal income tax breaks, but Minnesota still restricts its incentives to higher education spending.
• Minnesota is one of seven states that allow their residents to claim a state income tax incentive whether they contribute to the home-state plan or a different 529. The incentives aren’t restricted to family members. Any Minnesota resident can claim a tax incentive for contributing to a 529 plan for another person’s benefit.
• At tax time, filers choose between a tax credit or a tax subtraction. The maximum benefit Minnesota offers is a $500 nonrefundable tax credit. To get the full amount, a tax filer must contribute at least $1,000 to a 529 plan while reporting adjusted gross income of no more than $75,000. The tax credit’s value shrinks for higher earners. Very low earners who don’t pay income tax do not qualify because the credit is nonrefundable. The average filer’s 529 plan tax credit in 2017 was worth $271.
• In the alternative, tax filers can claim a tax deduction, or subtraction, which reduces their taxable income. There is no limit on a filer’s income for the subtraction. The state’s highest earners can reduce their tax liability by $295.50 for making $3,000 in contributions to a 529. The average 2017 tax subtraction was worth roughly $162, according to a Department of Revenue estimate.
Clausen said he had tried to make the tax credit refundable so that very low-income families could benefit. He’d also support an income ceiling for the incentives, saying he can’t explain why the tax subtraction didn’t include one in the first place.
Eleven states offer subsidies to low-income families who invest in a 529 plan, according to the Brookings report. However, as Minnesota learned with its defunct matching grants, few families take advantage.
The 529 plan grants the Legislature eliminated in 2011 offered a 15 percent match on contributions for families with adjusted gross incomes under $50,000, and a 10 percent match for incomes up to $80,000. The matching grant was capped at $400.
In 2006, Minnesota budgeted $1 million for the matching grants. It awarded just $245,000.
Despite their inherent inequities, 529 plan incentives have proved politically resilient.
The federal income-tax-free provision was signed into law by President George W. Bush in 2001 — the same year Minnesota’s 529 plan began operating.
When President Barack Obama proposed repealing the 529 plan law in 2015, he quickly retreated amid backlash from both Republican and Democratic leaders worried about angering the upper middle class.
States eagerly have encouraged their residents to contribute to 529 plans. At the time the Brookings report was published, in 2017, there were 33 states offering their own income tax incentives.
Besides highlighting the 529’s regressive nature, the Brookings report raised doubts about whether the plans actually meet the goal of getting families to save more for college.
Because there is no requirement that the funds be newly invested, a well-off parent could simply transfer funds into a 529 plan from other vehicles, such as regular brokerages or IRAs, in order to take advantage of their state’s tax breaks.
It’s hard to tell what impact the 2017 incentives actually have had on college savings, but there’s been a modest increase in contributions to the state’s 529 plan.
In 2016, the year before the tax incentives were written into law, the state-run 529 plan opened 4,407 new accounts.
The number of new accounts opened in 2017 was 5,643 and 7,199 a year later.
Total dollars contributed to the state plan grew by 6 percent and 9 percent with the incentives in place after 3 percent increases the two previous years.
That doesn’t capture the entire picture, however, as Minnesotans who invest in other states’ plans can cash in on the state tax incentives.
On the other hand, it’s likely some families made their contributions with funds from other types of accounts they already had pegged for college. A Minnesota resident who pays attention to tax laws can get up to $500 from the state each year without actually setting additional money aside for college.
It’s also possible some of the increased contributions could be related to Congress making K-12 private school tuition eligible for 529 plan spending, even though the state did not.