Our recent report, “ New Lessons About 529s,” found that American households would collectively have $237 billion more in assets if they put their college savings exclusively into 529 plans. This is undoubtedly an impressive number, but these gains aren’t evenly distributed.
The impact that 529 plans have on a family’s college savings varies significantly and should be carefully considered when deciding if a 529 plan is worth it. Based on our research, the effectiveness of switching to a 529 plan for college savings depends on a few aspects: whether college funds are invested, how much is saved, and where the family lives.
2 considerations for investors to determine if a 529 plan is worth it
- The success of 529 plans depends on how much you save, and where. As we mentioned in an earlier blog post, the driving force behind the power of 529s is that they’re primarily investment vehicles. Since many parents currently hold their college savings in checking and savings accounts, using a 529 plan instead can help those families earn a much higher rate of return over time. Here’s where the benefits and disadvantages of 529 plans begin to diverge, as certain families tend to hold more in savings and checking accounts than others. The table below shows this in more detail, based on microdata from the 2018 Sallie Mae study, “How America Saves for College.” Low-income families generally don’t have enough saved to see a substantial benefit from investing, so 529s may not be right for them, given the added risk and their need for liquidity. Many high-income families already use 529s or other investment vehicles, so a change isn’t necessary. Middle-class Americans, in comparison, would benefit the most from transitioning to a 529. These families tend to have the most sitting in checking or savings accounts, which offer a net return of close to zero.
- 529 plans may be less effective depending on where you live. Although the tax benefits of 529s have a smaller impact, they still account for nearly one-third of the total benefit. Here, too, there's a nuance that must be considered—529s may be less relevant for families living in low-tax or low-tax deduction states. Let’s look at an example: a married couple with two children, ages 4 and 7, earning $73,000 a year, and with total college savings of $20,000, all outside of a 529 (half is invested, half is in savings). If they lived in California, a state with no 529 deduction, and maintained that rate of saving until their children were 18, they would have roughly $40,000 per child. If they invested that money in a 529 plan, they would have more than $49,000 per child—a sum rather similar to the outcomes of a typical investment account. If an otherwise identical family lived in Illinois, however, they would have $51,700 per child because of the tax benefits.
Are 529s appropriate for your clients?
Our research found that 529 plans are extremely powerful and can help many people substantially increase their college savings—but some individuals may face more disadvantages than others. Based on their current savings allocations, 529 plans may not be the right choice for families with too little saved or for families that are already investing their savings. Also, 529 plans may be less relevant for families in low-tax, low-deduction states because of lost tax incentives.
These nuances show that when it comes to financial planning, personalized financial advice is essential. Each family is different, and their decision to invest in a 529 must depend on their specific circumstances and preferences. For some families, their current investing strategy may outweigh the tax benefits of 529s, especially given the sub-par investment choices some 529s plans offer. Other families may not be comfortable with the added risk of 529 plans and choose to forego those added gains. Given the amount of assets at stake, however, it’s essential for families, and their advisors, to carefully determine which 529 option, if any, is right for them.