529 Plans: A Summary
Saving for education is one of the primary financial goals of mutual fund shareholders, which is not surprising in light of the findings of the Education Commission of the States 1 (ECS) that approximately 57 percent of high school seniors who graduate are likely to enroll in college within a year. Unfortunately the costs of higher education are skyrocketing.
According to the ECS:
“In a growing number of states, people’s opportunity to obtain a postsecondary education—as well as the state’s ability to provide one—is being seriously challenged. The risk is that competing public priorities and shrinking resources will put access to an affordable and high-quality college education further out of reach for more and more Americans. The participation gap that separates those with access to college from those without it is threatening to widen. … Twenty years ago, a high school diploma was all that was needed to secure a spot in the middle class; today, a postsecondary education is mandatory. The majority of new jobs created since 1983 that pay a livable wage now require some form of education and training beyond high school.”
See Closing the College Participation Gap A National Summary, ECS October 2003.
The increasing costs of higher education do not merely affect college-bound high school seniors. According to the ECS, “adults age 25 and older account for 47 percent of total [college] enrollments.” Based upon these findings, saving for education is more important than ever, and tax-advantaged savings vehicles that can be used to pay for higher education, such as 529 plans, are becoming increasing more attractive to investors. Importantly, 529 plans can be used to cover qualified higher education expenses irrespective of the age of the student—making them attractive savings vehicles for both younger and older students.
College Costs Are Climbing
Since 1980, the cost of higher education has been rising more rapidly than the Consumer Price Index, according to the College Board. Moreover, in recent years, federal financial aid for higher education has shifted largely toward loans and away from grants. As a result, the percentage of family income required to pay the cost of higher education has increased significantly.
Average Annual Higher Education Costs 2006-2007
(includes in-state tuition, fees, room and board)
| School Type | Cost | Percent Change |
| Two-year public | $2,272 | 4.1 percent increase from 2005–2006 |
| Four-year public | $12,796 | 5.6 percent increase from 2005–2006 |
| Four-year private | $30,367 | 5.7 percent increase from 2005–2006 |
Source: Trends in College Pricing, 2005, The College Board
Many Parents Are Saving for College
A 2003 ICI survey of parents with children age 18 or younger found that nearly two-thirds were saving to pay for their children’s college education. The survey indicated that parents’ decision to save for college expenses is influenced by the level of parents’ own education, their age, and the number of children they are raising. The median number of years parents participating in the survey had been saving for college was 6.0 years; the mean was 7.6 years. The median amount they had saved was $10,000; the mean amount saved was $23,600. Most of the parents in the survey were confident that they will reach their college savings goals: 38 percent thought it was “very” likely that they will meet their college savings goals, and 49 percent thought it was “somewhat” likely.
Helping Americans Prepare Financially for Higher Education
Recognizing the economic and social benefits of promoting education, federal and state lawmakers have developed a number of innovative programs to make higher education financially accessible to more Americans. In recent years, growing numbers of families are turning to one of these options, qualified tuition programs, as a way to help finance the higher education expenses of their children or grandchildren. These programs, commonly known as “529 plans” for the section of the tax code that authorizes them, are investment plans designed to pay for future qualified education expenses.
Two Types of 529 Plans
There are two types of 529 plans: prepaid tuition programs, which are set up to allow an individual to prepay a student’s future tuition with today’s dollars; and college savings plans, which allow individuals to contribute to an account established to pay a student’s qualified higher education expenses at an eligible educational institution. Today, all states and the District of Columbia offer either prepaid tuition programs, college savings plans, or both. In addition, a group of close to 300 private U.S. colleges and universities offers a prepaid tuition program called the Independent 529 Plan.
College Savings Plans
Beginning in 1996, Congress authorized college savings plans to allow individuals to contribute to an account to pay a beneficiary’s qualified education expenses, such as tuition, fees, books, supplies, and room and board. The value of college savings plans is based on the money contributed by the account holder and the performance of the particular investments or investment strategy he or she has chosen. As a result, college savings plans generally carry investment and market risks.
Contributions to college savings plans have been growing as the public becomes aware of their desirability as savings vehicles. Surveys of state plans indicate that assets held in 529 college savings plans grew from $200,000 in 1998 to $90.1 billion at the end of 2006. Assets in Section 529 savings plans grew 31 percent in 2006, increasing from $68.7 billion at year-end 2005. The number of accounts rose to 7.2 million, and the average 529 savings plan account size was approximately $12,500.
Many mutual fund companies manage college savings plans for states, and mutual funds are the most commonly used investment vehicle in these plans. Each state’s plan typically offers a variety of investment options, for example: a portfolio of stocks and bonds whose percent composition changes automatically as the beneficiary ages; a portfolio with fixed shares of stocks and bonds; or a portfolio with a guaranteed minimum rate of return.
529 College Savings Plan Growth, 1998–2006
(assets in billions of dollars)
Note: Data were estimated for a few individual state observations in order to construct a continuous time series.
Sources: Investment Company Institute and College Savings Plans Network
Prepaid Tuition Plans
These plans allow an individual to establish an account in the name of a student to cover the cost of a specified number of academic periods or course units in the future at either current prices or discounted current prices. The vast majority of prepaid tuition plans are state-sponsored and only permit the prepayment of tuition at colleges and universities within the sponsoring state,. There is, however, one privately sponsored prepaid tuition plan, which has been available since 2003. This plan, called the Independent 529 Plan, offers participants the opportunity to prepay tuition at a discounted rate at approximately 300 private colleges and universities in the United States. A prepaid tuition plan account (both public and private) may be funded by lump sum or periodic cash payments. These programs, which provide a hedge against tuition inflation, enable the program sponsor to pool money and make long-range investments so that the earnings meet or exceed college tuition increases. As such, the program sponsor bears the risk that the earnings will, in fact, cover the cost of the education purchased by the account holder and the account holder is not entitled to recoup these earnings from the program sponsor. Generally, however, the account holder is guaranteed that, regardless of tuition inflation, the account will cover the cost of the number of academic periods or course units purchased by the account holder. In the event the account beneficiary does not utilize the account to pay for his or her higher education, the account owner is typically only entitled to obtain the principal invested in the account. The specifics of these programs vary greatly from one state to another, and state-sponsored programs differ from the Independent 529 Plan. Accordingly, an investor should consider his or her various options before investing in a particular plan.
529 Prepaid Tuition Plan Growth, 1998–2006
(assets in billions of dollars)
Note: Data were estimated for a few individual state observations in order to construct a continuous time series.
Sources: Investment Company Institute and College Savings Plans Network
Tax Treatment of 529 Plan Contributions and Earnings
Contributions to 529 plans are made with after-tax dollars and earnings grow tax-free. However, as mentioned above, an investor in a prepaid program typically is not entitled to these earnings. Earnings withdrawn from 529 savings plans to pay for qualified higher education expenses are free from federal income tax. State-tax treatment of college savings plan contributions and earnings varies from one state to another.
A number of states provide partial or full income tax deductions for contributions to the state’s 529 plan. In addition, some states provide residents with a state tax break on earnings distributions from their state’s 529 plans that are used to pay qualified education expenses. Some states also offer other benefits to their residents who invest in their home state’s plan (e.g. matching grants). These state tax and other advantages may or may not be available to investors who purchase a plan from another state or from the Independent 529 Plan. An investor should consider the state tax consequences and benefits of in-state, out-of-state plans, and private plans before investing.
For the latest legislative and regulatory developments concerning 529 plans and other related issues, return to the education savings index page.
Ownership of 529 Plans
Among parents who participated in ICI’s survey and were saving for college, 7 percent owned state-sponsored 529 prepaid tuition plans and 8 percent owned state-sponsored 529 college savings plans. (At the time of the ICI survey, the Independent 529 Plan was not available to investors, so data concerning investors in that plan were not captured by the survey.)
Characteristics of Households Saving for College Using
State-Sponsored 529 Prepaid Tuition Plans or State-Sponsored 529 College Savings Plans
| Using State-Sponsored 529 Prepaid Tuition Plans to Save for College |
Using State-Sponsored 529 College Savings Plans to Save for College |
|||
| Median | ||||
| Age1 | 42 years | 40 years | ||
| Household income | $100,000 | $100,000 | ||
| Household financial assets2 | $109,400 | $ 150,000 | ||
| Percent | ||||
| Household decisionmaker: | ||||
| Male is sole decisionmaker | 12 | 11 | ||
| Female is sole decisionmaker | 7 | 8 | ||
| Co-decisionmakers | 81 | 81 | ||
| Number of children age 18 or younger in household: | ||||
| One | 27 | 30 | ||
| Two | 56 | 49 | ||
| Three or more | 17 | 21 | ||
| Married or living with a partner1 | 95 | 96 | ||
| College or postgraduate degree1 | 71 | 81 | ||
| Employed1 | 90 | 89 | ||
| Retired from lifetime occupation1 | 7 | 2 | ||
| Own outside employer-sponsored retirement plan or IRAs:3 | ||||
| Bank savings accounts | 95 | 92 | ||
| Individual stocks or bonds, mutual funds, or annuities (total):3 | 83 | 85 | ||
| Mutual funds | 68 | 70 | ||
| Individual stocks or bonds, excluding U.S. Savings Bonds | 59 | 60 | ||
| Fixed or variable annuities | 24 | 21 | ||
| U.S. Savings Bonds | 61 | 60 | ||
| Certificates of Deposit | 37 | 34 | ||
| Other investments | 17 | 21 | ||
| Participate in or covered by employer-sponsored retirement plan | 87 | 89 | ||
| Have traditional or Roth IRA | 64 | 75 | ||
1Refers to the household's responding financial decisionmaker for investments.
2Includes assets in employer-sponsored retirement plans but excludes primary residence.
3Multiple responses included.
Note: Number of respondents varies.
Ownership of State-Sponsored 529 Prepaid Tuition Plan Accounts
Parents in the ICI survey who owned state-sponsored 529 prepaid tuition plan accounts typically had opened two of these types of accounts. The most common reason they mentioned for opening state-sponsored 529 prepaid tuition plan accounts was that their children's tuition would be paid in advance. Parents owning state-sponsored 529 prepaid tuition plan accounts most often obtained information about the plans from the sponsoring states. (By contrast, as discussed below, most parents obtained information about 529 savings plans from financial professionals.) According to the 2003 survey, the median amount invested in state-sponsored 529 prepaid tuition plan accounts per household was $5,000; the mean amount was $14,500.
Households using state-sponsored 529 prepaid tuition plans to save for college had a median income of $100,000 and median financial assets of $109,400. These households typically were headed by individuals who were employed, married or living with a partner, college-educated, and in their early forties. Eighty-seven percent of these households participated in or were covered by employer-sponsored retirement plans and nearly two-thirds owned IRAs. In addition to participating in employer-sponsored retirement plans and IRAs, most also owned bank savings accounts, mutual funds, U.S. Savings Bonds, and individual stocks or bonds.
Ownership of State-Sponsored 529 College Savings Plans
Parents in the ICI survey who owned state-sponsored 529 college savings plan accounts typically had opened two of these types of accounts. Eighty percent of these parents purchased their home state's college savings plan; 20 percent purchased an out-of-state plan. However, 46 percent of parents with 529 college savings plan accounts considered both the home state's college savings plan as well as college savings plans offered by other states. The two most frequently mentioned reasons for opening state-sponsored 529 college savings plan accounts were flexibility in selection of a college or university and the types of investments offered by the plans. The largest percentage of parents with 529 college savings plan accounts, 64 percent, obtained information about 529 college savings plans from professional financial advisers. More than half of parents with state-sponsored 529 college savings plans opened their accounts through professional financial advisers, and slightly more than one-quarter opened their 529 college savings plan accounts through the states offering the plans. As of 2003, the median amount per household invested in state-sponsored 529 college savings plan accounts was $5,000; the mean was $11,200.
Households with 529 college savings plan accounts had a median income of $100,000 and median financial assets of $150,000. These households were headed by a parent with a median age of 40 who was usually employed, married or living with a partner, and college-educated. Eighty-nine percent of these households participated in or were covered by employer-sponsored retirement plans. Three-quarters owned traditional or Roth IRAs. Most also owned investments outside employer-sponsored retirement plans and IRAs, such as bank savings accounts, mutual funds, individual stocks and bonds, and U.S. Savings Bonds.
Additional Resources
- A Guide to Understanding 529 Plans (pdf)
- A Guide to Understanding 529 Plans (html)
- The College Savings Plans Network
- Tax Benefits for Higher Education, Internal Revenue Service
- Independent 529 Plan
- 529 Program Statistics, College Savings Plan Network 529 Program Statistics
- Profile of Households Saving for College, Fall 2003, Investment Company Institute
Endnote
May 2007
