Rethinking America’s College Savings Programs

With the start of summer comes graduation season, and along with it, a sense of excitement for the future. But while a new cohort of high school seniors prepares to depart for college, for many young adults, higher education remains out of reach. 

Students from high-income backgrounds are better represented at colleges across the United States than those from low-income backgrounds, with some schools admitting more students from families in the top one percent of earners than from families in the entire bottom 60 percent. While schools have tried to adjust for this disparity, the truth is that unless the overall cost of tuition falls drastically, college will remain accessible only to the financially capable.

Fortunately, the financial services industry holds great potential for helping to correct this imbalance. With the proper adjustments, the financial sector can effectively help families prepare for the financial burden of higher education and significantly reduce this college attendance disparity. 

Seeds of change 

So long as the cost of college remains high, families must start saving as early as possible. Research in the field provides evidence that current savings vehicles hold promise for changing the narrative. SEED OK is a Child Development Account (CDA) program in Oklahoma, designed and tested by researchers at the Center for Social Development at Washington University in St. Louis. In a randomized controlled trial, the SEED OK team randomly assigned parents of newborns to receive an account with an initial deposit of $1,000. After 11 years, researchers at the Center for Social Development reported that the program improved outcomes such as asset ownership, mental health among mothers, and educational expectations. Better yet, the benefits of having money in a CDA were even stronger for children from disadvantaged groups, as these families were less likely to have assets outside of the framework of the program. 

But while CDAs can help to bridge the gap—especially when programs have funding to offer seed deposits and match parent contributions—there are significant barriers to encouraging families to contribute their own money into college savings accounts. Through multiple programs and experiments in our research at Common Cents Lab, we’ve found that even the behavioral “nudges” that prove so effective in other areas of saving and budgeting, such as text-message reminders, fall flat.

In our most successful experiment to date, we found that sending account statements home to families in their kindergarten children’s backpacks rather than through the mail helped increase account deposits. But even then, only 65 of the 4,500 families in the program made deposits. With less than 2 percent participation, we have little evidence that small behavioral interventions are sufficient when the barriers to engagement are so high.

This is likely because the gap that low- to moderate-income families need to overcome is too substantial. Building a short-term savings account to cover three months’ worth of household expenses is challenging enough, let alone financing a four-year degree. The time horizon further complicates the matter: The benefits of saving can be more than 10 years away in the case of young children.

Saving is hard to encourage and sustain, even if a program’s roots are strong. So how do we proceed? To tackle this challenge, we need to reinvent the way Americans approach college savings.

The future of college savings

Instead of relying on individual programs or behavioral nudges, we propose using behavioral insights to build better college savings mechanisms from the ground up. Rather than implementing small tweaks to existing frameworks, we can apply effective savings strategies from research on financial behavior to institutionalize college savings. To restructure the college savings landscape, governments and financial providers should employ a three-pronged approach:

1. College savings accounts for every child, opened at birth

Encouraging families to open college savings accounts at birth creates an expectation that they should be thinking about higher education and how they will finance it as early as possible. To date, only a handful of US states have implemented statewide children’s savings programs, though momentum has increased with legislators proposing programs at the federal level, as well.
 
Policies that automatically open accounts for all children also provide a platform to address wealth inequality. By offering greater subsidies for low-income families, as in the SEED OK program, we can even the playing field between families with different levels of existing assets. A policy of this scale has the potential to address the racial wealth gap as well; scholars Darrick Hamilton and Sandy Darity have similarly proposed “baby bonds” as a way of reducing inequality that can stem from generational wealth transfers.
 
This solution must originate at the highest policy levels in order to set standards for behavior. For a model of how these accounts might function, we can look to the work of Michal Grinstein-Weiss and colleagues at the Center for Social Development. Grinstein-Weiss outlined the legislative and programmatic components necessary to launch a universal CDA for all children born in Israel. With restricted access to funds at age 18, progressive contributions from the government, and centralized account administration as core features, this program has seen great success since launching in January of 2017. Not only do families accumulate assets through government contributions, but also more than 40 percent of all Israeli families have made contributions of their own. While we don’t fully know the budget required to operate such a program in the United States, the downstream economic benefits of expanding higher education will certainly outweigh the upfront costs.

2. Employer-supported savings programs

Helping people balance the need to save for multiple long-term goals is another challenge in promoting college savings programs. Research suggests that the most effective way to increase retirement savings is by making the process automatic: Opt people into employer-sponsored accounts with default contribution rates and investment allocations. By elevating college savings to the level of importance of retirement savings, we can adopt these same, well-established strategies.

Employer-supported college savings programs can be paired with the universal accounts outlined above. When employees have children, employers can offer payroll deductions with matches into these accounts. Employers can also suggest default contribution rates that balance different savings needs, such as splitting an existing 8 percent retirement contribution equally between a college savings account and a retirement account, or even rounding up a current contribution when feasible to account for both goals. 

Employer-sponsored programs should also be available to people without access to traditional retirement options through their employers. This is where innovative financial organizations come in. We worked with Self-Help Credit Union to model this idea by developing a retirement account for credit union members without workplace retirement plans. Rather than pulling funds from a paycheck, a percentage of each checking account deposit is automatically deposited into a retirement account to ensure a steady stream of savings without the risk of overdrafts. Within 10 months of launching the experiment with eligible credit union members, 36 percent of members had opened accounts and saved an average of about $340 each.

3. Tech solutions to automate savings decisions

With established college savings programs at birth, reinforced by employer matches and savings programs, we can elevate the importance of college savings. But we must also create platforms that make the choices around saving as frictionless as possible. For example, if employers provide suggestions for default contributions, we need the backend technology to help people determine the most effective way to split an employee’s assets to cover their goals.

Consider a tech platform where people indicate the total amount they are capable of saving each week. Based on target college and retirement dates, we can establish what percent of their total savings needs to be allocated to each goal. People can then make a single savings payment that is split between accounts on the back end, reducing the pain of making multiple payments. This type of solution also enables us to display multiple savings account balances on a single platform, making it easier for people to monitor their progress and providing opportunities to test different strategies to encourage increases in saving.

These behavior-focused solutions are a start, however, redesigning college savings will require a larger overhaul of existing approaches to financial decision-making. Everyone from financial advisors to fintech companies can play a role in establishing new social norms around saving for higher education. Financial institutions can recommend saving for college as frequently as they recommend saving for emergencies. Even schools can contribute by prompting savings deposits at moments when families are already paying school fees. By leveraging multiple approaches, we can begin to communicate expectations about the necessity of saving for college. Spreading out the message also maximizes our likelihood of catching people at a time and place when they can take action.

Helping families build assets for higher education will require that policymakers, industry professionals, and researchers alike collaborate. But while the task is lofty, so is the potential payoff of reducing wealth and educational inequality.

Read more stories by Stephanie Tepper & Mariel Beasley.