Many states have introduced so-called 529 savings plans in recent years in order to encourage families to save money to fund their children’s college education. Under these plans a family can set aside savings for higher education with a tax advantage. Interest earned on college savings in this plan is not taxed by the state. Use a graphical life cycle model to illustrate and analyze the program’s efficiency effects.
a. Demonstrate and explain how the savings plan affects a family’s budget line.
b. Demonstrate and explain how the savings plan affects a family’s savings.
c. Explain the conditions under which a family will save more for college as a result of this program.