In this paper, the authors use an expected utility framework with a mean-lower partial moment specification for investor utility to determine the asset allocation and the allowable contribution limits for qualified state-sponsored tuition savings plans. Given their assumptions regarding state policymakers" perception of investor utility, they determine the necessary level of contributions needed to fund five years of education at the most expensive higher education institution in the nation, as allowed by the IRS regulations for Section 529 plans. Their approach determines simultaneously (1) the optimal asset allocation and (2) the annual contribution level needed in order to achieve the savings target.
The modeling framework incorporates a specific, and the authors believe reasonable, definition of risk aversion and optimal investment behavior. This framework allows the determination of "appropriate" contribution levels, and enables analysis of the interaction between the contribution limits and risk-taking. The results of their research may have implications for the determination of contribution limits under the current IRS regulations for tuition savings plans.
The remainder of the paper is structured as follows: background information on qualified tuition plans; the saving and asset allocation model used in the analysis, with an explanation of how various parameters in the model are calibrated; the baseline simulation results and some sensitivity tests; and some concluding remarks.
