529 plans save families billions of dollars in federal income tax

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Kathryn Flynn

By Kathryn Flynn

October 22, 2018

529 plans experienced record growth over the past decade. According to a new study from Pew Research, the number of 529 plan accounts, total assets in 529 plans and 529 plan account balances have hit all-time highs. Along with this growth, more families are taking advantage of 529 plan tax benefits. The study reports a 25 percent increase in 529 plan federal tax savings from 2010 to 2017, and a similar boost in state tax savings.

529 plan usage is on the rise

The number of 529 plan accounts jumped from 10 million in 2010 to 13 million in 2017. During the same time period, the number of children under 18 declined by 0.7 percent. This implies that the number of children with 529 plans has increased and/or the number of 529 plans per child has increased.

529 plans can have only one beneficiary, but there is no limit to the number of 529 plan accounts per beneficiary. For example, a child can be the beneficiary of 529 plans owned by the child’s parent, grandparent, aunt and uncle.

As of June 2017, total assets in state-sponsored 529 plans were around $318 billion, an 81 percent inflation-adjusted increase from 2010.

Average 529 plan account balance is growing

A combination of increased contributions and investment growth has driven individual 529 plan account balances to all-time high of $24,057. Yet while this figure is high relative to prior years, it is low when compared to actual college costs.

Based on the College Board’s Trends in College Pricing report, and assuming current college inflation rates of 3.1%, to 3.5%, the total cost of 4 years of college for today’s freshman will be around:

  • Public 4-year college (in-state): $87,000
  • Public 4-Year College (Out-of-State): $153,000
  • Private Non-Profit 4-Year College: $198,000 

Families with young children can use a college savings calculator to project future college costs and determine how much more they will need to save. If the beneficiary is close to college age, parents will need to close the savings gap with scholarships and grants, contributions from income, and student loans. 

529 plan tax savings hit record high

Taxpayers saved $2 billion in federal income tax in 2017 by saving in 529 college savings plans. Unlike a mutual fund or other taxable account, investment earnings grow tax-free in a 529 plan and are not taxed when distributions are used to pay for qualified higher education expenses.

Some states also offer income tax breaks for families who save for college with 529 plans. All states (that have income tax) exclude 529 plan earnings from income, and more than two-thirds allow taxpayers to deduct all or a part of 529 plan contributions from income. Four states – Indiana, Massachusetts, Utah and Vermont – offer eligible taxpayers an income tax credit for 529 plan contributions.

Although data is limited, the study reports increases in state income tax savings for 529 plan users. With the exception of Montana, Rhode Island and Wyoming (which does not have a 529 plan), total assets in 529 plans have grown by at least 50% in every state since 2010.  Offering a state income tax credit or deduction for 529 plan contributions does not necessarily have an impact on the state’s total 529 plan assets or residents’ income tax savings.

For example California residents saved an estimated $57.5 million in state income taxes in 2017 by saving with 529 plans. California offers income tax-free 529 plan distributions, but does not provide an additional state income tax deduction or tax credit for 529 plan contributions. But in Pennsylvania, a state that allows residents to deduct up to $15,000 annually for 529 plan contributions, tax savings were only $32 million.  However, California has more than three times the population of Pennsylvania.

The District of Columbia saw the biggest increase in 529 plan assets form 2010 to 2017, at 246%, followed by Utah (217.5%), Arkansas and Nevada.

Additional tax savings expected as families use 529 plans for K-12 tuition

The Pew Research study was conducted before the 2017 Tax Cuts and Jobs Act, which expanded 529 plan qualified expenses to include up to $10,000 in K-12 tuition. Legislation is currently pending that will expand qualified K-12 expenses further, and include homeschooling costs, apprenticeship programs and student loan payments as qualified 529 plan expenses. With these expanded benefits,  529 plan participation may reach even higher levels.

A good place to start:

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