Government-sponsored education savings plans: wonderful or just good for the rich?

by Alan Cohen

Yesterday I was talking to my banker about the government-sponsored education savings plans available here in Canada. With a child on the way, I wanted to inform myself about the options. I was stunned by what I learned – I can contribute up to $2500 per year to an account, and the government will chip in an additional 30%. All interest is tax-free until withdrawn, and then is taxed to the child/student (who may have no tax liability at age 18). Given that the costs of education are already really low here compared to the states (about $200 tuition per session for CEGEP, the two-year program between high school and college, and about $4000 per year for university), most of the savings can be used toward room and board. (As an example, here are the current tuition charges for a Bachelor’s in Arts and Sciences at McGill, the best university in Quebec and one of the top twenty in the world, for a Quebec resident. $2200 for tuition, $3700 after adding in all fees and mandatory insurance (such as dental).)

Coming from the States, this is amazing. Tuition at Harvard is now $37,500 per year, and with estimated living and other expenses this climbs to at least $58,000. Again, that’s per year. I know there are some education savings plans available in the US, but I’m pretty sure no state offers to contribute 30%. So my first reaction on hearing this was to be really really impressed with Canada (once again). Yes, taxes are high, but health care is free, day care (in Quebec) costs $7 per day, and now this. Plus, the banking system is stable, the people are friendly, and the beer is excellent. What’s not to love?

Then I started thinking about this in light of the recent debates on tuition hikes here in Quebec. “Debate” is somewhat of a euphemism – the students went on strike, there were riots in the streets, vandalism, police brutality, and all the tensions and emotions that go with that. The government wanted to raise tuition to help balance the budget and pay for improvements to universities. The students (at least many of them) opposed any tuition increase on principle. The resulting discord toppled the government, but did not resolve the crisis. And for what? The proposed tuition increase was $1625 per year, to be phased in over 5 years in $325 increments. That is a substantial increase, but it’s still very small compared to the US or even Ontario. And when combined with an education savings plan? What is there to worry about?

What there is to worry about is that not every family can contribute $100/month to their children’s education funds. $4000 or even $6000 may not be a lot of money compared to Harvard, but cumulated (along with living expenses) over several years, that’s still a lot of debt. A lot of debt that a student from a poor family would have to take on, but that our son won’t. Enough debt that many poorer students may feel that such an education is beyond their means.

In other words, we all (rich and poor) pay taxes so that the government will match 30% of our contributions, but the benefits only go to families with enough income to make contributions, in proportion to their income, something like this:

Income and educ savings


I’m just guessing here on how much people of different incomes would be able to contribute, but the general pattern will almost certainly hold: the poorest do the worst, benefits accumulate as one moves through different levels of being middle class, and those most comfortably off benefit the most (though the very rich do no better than the upper middle class).

Considering that a student will be in CEGEP and university a total of 5 years, but that such a savings plan could accumulate over 20 years at up to $750 of government contribution per year, it would seem that a good alternative would be to shift these government contributions in order to make tuition free, and then use whatever is left as a smaller (5%? 10%?) matching amount for education savings accounts that would help pay for living expenses during college.

The tricky bit here is that, for lower middle class families, the incentive to save for college (an excellent thing) is proportional to the matching amount. As the matching amount decreases, so does the incentive, and the whole curve shifts right:

Income and educ savings2


Not only does the contribution starting point shift, so does the slope, so that the benefit favors the rich even more. (In other words, with a smaller incentive, you will contribute less of each additional dollar you make to the fund.) This is still probably better than the current system, since tuition would be free. But there’s a tricky catch-22 here: we probably don’t really want the government to outright pay for living expenses during college (this would encourage people to go to college instead of work even when they don’t need or want the education); at the same time, as long as living expenses are a constraint, a savings plan like this one is a great idea. And it’s pretty hard to design a savings plan that doesn’t favor the rich.

Any of my readers have good ideas on how to avoid this catch-22? I’d love to hear in the comments section…