AN ANALYSIS OF SECTION 529 COLLEGE SAVINGS AND PREPAID 

TUITION PLANS

A REPORT PREPARED BY THE DEPARTMENT OF TREASURY FOR THE

WHITE HOUSE TASK FORCE ON MIDDLE CLASS WORKING FAMILIES

SEPTEMBER 9, 2009 
1

EXECUTIVE SUMMARY1

Making college education more affordable is a central goal of the Obama Administration 

and has been a focus of Vice-President Biden’s Taskforce on the Middle Class. To that 

end, the Task Force asked U.S. Treasury Department to prepare this report on how to 

make Section 529 college savings plans a more effective and reliable tool for families to 

save for college. 

The report discusses the benefits of 529s as a way to build savings for this critically 

important investment, the extent to which Section 529 plans serve various income groups, 

and how well the plans keep costs low so to maximize returns to savers. In addition, as 

requested by the Vice President, the report highlights exemplary practices and makes a 

set of recommendations on how to make Section 529 plans more effective and reliable. 

The report relies on information from a variety of sources, including academic research, 

an extensive database maintained by the College Savings Network (CSPN) on Section 

529 plan features and investment options, and 66 submissions that were received in 

response to Treasury’s request for information posted in the Federal Registry. 

BACKGROUND

• A Section 529 plan is formally a “qualified tuition program.” These programs are 

generally administered by the states. Currently, Section 529 plans are offered by the 

District of Columbia and all states except Wyoming, and one non-profit consortium 

of 127 private colleges that operates the Independent 529 Plan. 

• Section 529 plans are of two general types, prepaid tuition plans and college savings 

plans. In a prepaid tuition plan, tuition credits are purchased that entitle the 

beneficiary to a specified number of credit hours of future attendance at designated 

educational institutions. In a college savings plan, contributions are made to an 

investment account in which investment earnings accumulate free of federal tax, and 

from which account distributions are free of federal tax if used for qualified higher 

educational expenses. Both types of Section 529 plans receive the same federal tax 

benefits, which are analogous to a Roth Individual Retirement Account (IRA). In 

both cases, prepayments (or contributions) are made out of after-tax dollars, 

investment returns are untaxed, and the value of the education the investments 

finance is also untaxed. 

• Distributions from college savings accounts are not subject to federal tax only if used 

for the beneficiary’s qualified higher education expenses. Those expenses include 

tuition, fees, books, supplies, and equipment required for the enrollment or attendance 

at an eligible educational institution, and room and board expenses if the beneficiary 

is enrolled at least half time. In 2009 and 2010 only, computer purchases are also a 

qualified educational expense. Distributions not used to pay for qualified higher 

 

1

 This report can be found at www.treas.gov/press/releases/docs/529.pdf. 
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education expenses can be made to either the beneficiary or the account owner, but 

the portion of distributions constituting investment earnings are taxed at a penalty rate 

equal to the recipient’s ordinary tax rate plus 10 percentage points. 

• Section 529 plans also convey substantial state tax benefits. All states except 

Alabama do not tax Section 529 plan investment returns or Section 529 distributions 

to the extent that they are used for qualified higher education expenses, and a 

majority of states offer either a deduction or a credit for contributions to their own 

Section 529 plan. 

• In order to avoid misuse, Section 529 savings plan contributions are limited to what is 

necessary to finance the qualified education expenses of the beneficiary. States 

satisfy this requirement by refusing additional contributions to accounts once the 

account balance exceeds a dollar limit. This limit currently varies from $224,465 to 

$368,600 among the states, and equals or exceeds $300,000 in 29 states. These limits 

are per beneficiary per state. However, because 43 of the 48 states offering a Section 

529 savings plans are open to non-residents, a particular beneficiary can have 

accounts in as many as 44 states, each with a contribution limit of $224,465 or more. 

 

• Section 529 savings plans are of two general types—advisor sold plans offered 

through financial advisors, and direct sold plans for which individuals sign up and 

select investment options without a financial advisor as intermediary. For advisor 

sold plans, fees include periodic charges levied as a percent of account balances, 

“loads” levied either as a percent of asset purchases (front-load fees) or asset sales 

(back-load fees), and fixed-dollar annual account maintenance fees that are generally 

$50 or less. Direct sold plans assess only periodic charges on account balances and 

possibly annual maintenance fees; they do not impose load fees on purchases or sales. 

Advisor sold plan fees include compensation for the advisors, which contributes to 

fees being higher for advisor sold plans that for direct sold plans. 

• Section 529 savings plans tend to offer a variety of investment options that 

accommodate a wide variety of tastes concerning the tradeoff between risk and 

expected return. The investment options are almost always retail mutual funds 

offered to the general public, or combinations of such funds. Fees are higher than for 

the underlying retail funds because they include a program manager fee and most 

often a state fee as well. 

• The most popular Section 529 investment option is an age-based fund with an asset 

mix that is heavily weighted toward equities when the beneficiary is young but 

automatically becomes more weighted toward fixed income assets as the beneficiary 

approaches college age. Forty-nine of the 55 direct sold plans, and 22 of the 27 

advisor sold plans, offer age-based options. About 60 percent of Section 529 assets 

managed by one financial services company that manages six direct sold plans are in 

age-based funds. Only 23 states offer age-based index funds, however. 
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PRINCIPAL FINDINGS

• Section 529 plans are an attractive and convenient means of saving for college that 

offer substantial tax benefits. Illustrative calculations indicate that existing tax 

benefits can increase the effectiveness of saving by between 6 percent and 39 percent 

depending on the tax bracket of the saver, the length of the savings period, and 

whether there is a state deduction or credit for contributions. Other factors might 

influence the relative after-tax returns earned in taxed accounts and Section 529 

accounts, such as investment management fees. 

• Not surprisingly, Section 529 account balances and annual contributions appear to be 

skewed toward higher income families than is income. Possible explanations for this 

distributional outcome include: the tax benefits are greater for high-income families 

as they face higher tax rates; the savings rate in general increases with income as 

wealthier households need to spend a smaller share of their income on necessities 

such as food and clothing, and the likelihood of a child attending college increases 

with family income. 

• The current distribution of Section 529 account balances and contributions across 

income groups may not be problematic. It could be argued, for example, that the 

most effective way to help low income families with college expenses is through 

direct student aid, and that Section 529 plans are therefore naturally targeted to higher 

income families. It is for this reason that the report focuses on making Section 529 

plans more accessible, effective and reliable for the middle class. 

• Age-based index funds are offered by only 24 plans in 23 states. Index funds are 

passively managed so as to mirror the performance of a specific asset bundle, such as 

the 500 stocks making up the S&P 500 index. Since portfolio decisions are automatic 

and transactions are infrequent, expenses tend to be lower than those of actively 

managed funds. Index funds have been found to have two major advantages over 

actively managed funds. First, because of their low fees, they on average perform 

well relative to actively managed funds and have a large following in the investment 

community. Second, they are well suited to investors who do not wish to spend time 

acquiring information and evaluating the investment philosophy and track records of 

the various actively managed funds that are offered. 

• There is substantial variation in investment management fees across the 24 age-based 

index funds, likely reflecting variance in the administrative efficiency across plans 

that persists because limited inter-plan competition. 

• A major reason for this lack of competition between state plans is that currently 34 of 

the 42 states that both have an income tax and sponsor Section 529 savings plans 

offer either a state income tax deduction or a credit for contributions to their own 

Section 529 plan, but only five of those states offer a corresponding deduction or 

credit for contributions by in-state residents to Section 529 plans sponsored by other

states. In addition, 13 states exclude all or some Section 529 account balances from 
4

assets for purposes of calculating eligibility for state student financial aid, but none of 

those states offer a similar exclusion for the Section 529 account balances held by 

residents in the plans of other states. As a result of this “home-state bias,” families 

have strong incentives to choose their home state plan even if other plans offer 

preferable investment choices. 

RECOMMENDATIONS

The report recommends five approaches to making Section 529 savings plans more 

attractive, effective and reliable for middle class families, and those who aspire to join the 

middle class through college attendance. Among the recommendations are the following: 

• Provision of Age-Based Index Funds. Age-based investment funds are very popular 

and are well suited to the circumstances of many middle class families that are saving 

for college. Yet five of the 48 states offering a direct sold savings plan do not offer an 

age-based fund. Moreover, only 23 of the 43 states that do offer an age-based fund 

offer it in the form of index funds. Historically, index funds have performed well 

relative to actively managed funds because they have low fees, and they are 

especially well suited for investors who do not wish to spend time acquiring 

information and evaluating the investment philosophy and track records of actively 

managed funds. 

• Eliminate Home-State Bias. If home-state bias in state tax and student aid policies 

were eliminated, the result would be more investment options for consumers, more 

intense competition between plans, and very likely lower fees. To the extent that 

there are economies of scale in plan administration, consumers will also benefit from 

additional scale and lower costs. 

• Per Beneficiary Contribution Limits. Currently there are effectively no limits on 

Section 529 account balances. Because 43 states offer plans open to residents in 

other states, a beneficiary can have accounts in as many as 44 states, each state with a 

limit exceeding $224,465. Putting an effective limit on Section 529 contributions 

requires making the limits per beneficiary rather than per beneficiary per state. Per 

beneficiary limits would reduce the tax benefits to high income families and, by 

lowering federal tax expenditures for the program, would potentially free up federal 

resources for education aid that could be targeted to low and middle income families. 

Per beneficiary limits would best be enforced at the time distributions are made. 

Specifically, each distribution for a particular beneficiary’s qualified educational 

expenses would be divided into a principal portion counting against the contribution 

limit and an earnings portion. At such time as a beneficiary reaches the contribution 

limit, distributions would be nonqualified and subject to penalty. 
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I. INTRODUCTION

As part of its investigation into how to make college more affordable for middle class 

families, the Vice President’s Middle Class Task Force asked that the U.S. Department of 

the Treasury study ways of making Section 529 plans more effective and reliable. This 

report is the culmination of that study. It discusses the extent to which Section 529 plans 

serve various income groups, and how well the plans keep costs low and offer prudent 

investment choices so as to maximize returns and minimize risk to savers. In addition, as 

requested by the Vice President, the report highlights exemplary practices. 

The report relies on information from a variety of sources, including academic research, 

an extensive database maintained by the College Savings Network (CSPN) on Section 

529 plan features and investment options, and 66 submissions that were received in 

response to Treasury’s request for information posted in the Federal Registry. Treasury 

met with representatives of CSPN, the College Savings Foundation (CSF), the New 

America Foundation, the Center for Social Development at Washington University in St. 

Louis and several individuals to hear their views on the value of Section 529 plans and 

how they might be made more effective and reliable for middle class families.2

 

II. HOW SECTION 529 PLANS WORK

A Section 529 plan is formally a “qualified tuition program.” Section 529 refers to a 

section of the tax code that gives rules by which qualified tuition programs must abide in 

order to receive favorable federal tax treatment. Such programs can be administered by 

the 50 states and the District of Columbia, and by one or more eligible educational 

institutions. Currently, Section 529 plans are offered by the District of Columbia, and all 

states except Wyoming, and one non-profit consortium of 127 private colleges that 

operates the Independent 529 Plan. 

Section 529 plans are of two general types, prepaid tuition plans, and college savings 

plans. In a prepaid tuition plan, tuition credits or certificates are purchased on behalf of 

a beneficiary that entitle the beneficiary to a specified number of credit hours of future 

attendance at designated educational institutions, and the plan sponsor maintains a Trust 

that invests the prepayments and uses the proceeds to finance the tuition promised. In a 

college savings plan, contributions are made to an investment account with a designated 

owner and a designated beneficiary, the investment earnings accumulate free of federal 

tax, and account distributions are also free of federal tax if used for the beneficiary’s 

qualified higher educational expenses. While the two types of Section 529 plans appear 

dissimilar, they in fact receive the same federal tax benefits, which are analogous to a 

Roth Individual Retirement Account (IRA). In both cases, prepayments (or 

contributions) are made out of after-tax dollars, investment returns are untaxed, and the 

value of the education the investments finance is also untaxed. 

 

2

 Treasury also worked with the CSPN and CSF to devise a survey questionnaire that was distributed to 

Section 529 plan administrators. Unfortunately the survey data were not available in time to include in this 

report. Those data should be valuable for future follow-up analyses of Section 529 plans, however. 
2

While Section 529 plans are overseen by the states, all except five states contract out all 

or most of the management and recordkeeping functions to financial services companies, 

and all states contract out investment management services to financial services 

companies. 

Distributions from college savings accounts are not subject to federal tax if used for the 

beneficiary’s qualified higher education expenses. Those expenses include tuition, fees, 

books, supplies, and equipment required for the enrollment or attendance at an eligible 

educational institution, and room and board expenses if the beneficiary is enrolled at least 

half time. In 2009 and 2010 only, computer purchases are also a qualified educational 

expense. Distributions not used to pay for qualified higher education expenses can be 

made to either the beneficiary or the account owner, but the portion of distributions 

constituting investment earnings are taxed at a penalty rate equal to the recipient’s 

ordinary tax rate plus 10 percentage points. 

Section 529 plans also convey substantial state tax benefits. The District of Columbia 

and all states except Alabama do not tax Section 529 plan investment returns or Section 

529 distributions to the extent that they are used for qualified higher educations expenses. 

(Alabama does not tax distributions taken from its own plan, but does tax distributions 

taken from plans administered by other states.) In addition, 34 of the 42 states that both 

have an income tax and sponsor Section 529 savings plans offer either a deduction or a 

credit for contributions to their own Section 529 plan, and five of those states offer a 

deduction for their taxpayers who make contributions to Section 529 plans regardless of 

the state that administers the plan. State tax treatment of Section 529 savings plans is 

summarized in Table 1. 

Section 529 savings plans are required to provide safeguards to prevent contributions on 

behalf of the designated beneficiary that exceed what is necessary to finance the qualified 

education expenses of the beneficiary. States offering savings plans (all except 

Tennessee, Washington, and Wyoming) satisfy this requirement by refusing contributions 

to accounts once the account balance exceeds a dollar limit. This limit currently varies 

between $224,465 and $368,600, and equals or exceeds $300,000 in 29 states.3

 These 

limits are per beneficiary per state. Because 43 of the 48 states offering a Section 529 

savings plans are open to non-residents, a particular beneficiary can have accounts in as 

many as 44 states, each with a contribution limit of $224,465 or more. 

Contributions to Section 529 accounts can be made by anyone and constitute completed 

gifts to the beneficiary for purposes of estate and gift tax. Unlike other gifts, however, it 

can be elected that contributions be treated as if they were made over a five year period; 

hence, gift tax is avoided if contributions over a five year period do not exceed $65,000 

for single taxpayers and $130,000 for married couples (the current annual threshold 

multiplied by five). 

 

3 Most states base their limit on the cost of four years of undergraduate education and three years of 

graduate education, an approach sanctioned in a IRS private letter ruling to the New York State 529 savings 

plan. 
3

A Section 529 account must have one and only one beneficiary designated at all times. 

But the account owner can designate another family member as the beneficiary at any 

time, and can transfer balances to another account with a different same-family 

beneficiary. Hence a family with several children might have one account while the 

children are young, and could use that account to spawn others at such time as more than 

one child incurs qualified education expenses. 

Section 529 plans came about as a result of Michigan’s introduction of the first prepaid 

tuition plan in 1988. After much legal wrangling over the tax implications of the plan, 

the Internal Revenue Code was amended in 1996 to explicitly convey favorable tax 

treatment to Qualified Tuition Programs, albeit less favorable than today’s tax treatment. 

Earnings on investments financed with prepayments and held in trust by state sponsors of 

prepaid plans were treated like returns earned on municipal securities and hence were free 

from federal tax, but beneficiaries were made subject to tax on any difference between 

the value of education received and the amount of prepayments made. Similarly, the law 

made possible college savings plans where earnings were untaxed until withdrawn. In 

both cases, the tax benefit derives from the fact that tax on investment earnings is 

deferred and so compounding of earnings can accrue tax free. It was not until 2001 that 

the current tax rules making distributions entirely tax free were put in place with passage 

of the Economic Growth and Tax Reconciliation Act of 2001. Those provisions, which 

were set to sunset in 2010, were later made permanent with passage of the Pension 

Protection Act of 2006. 

Because Section 529 assets are considered municipal securities, they are not subject to 

the same regulations as other investments. Specifically, Section 529 plans are exempt 

from the Investment Company Act of 1940, the Securities Act of 1933, and the Exchange 

Act. Thus, fees, returns, and other standard disclosures are not required, and Section 529 

brokers are subject to the oversight of the Municipal Securities Rulemaking Board 

(MSRB) rather than the SEC. In response to concerns that disclosures were inadequate, 

the College Savings Plans Network (CSPN), in cooperation with the SEC and the MSRB, 

has developed voluntary disclosure agreements covering Section 529 plan returns, fees, 

and state tax benefits. The most recent agreement was agreed to by all plans in July 

2005.4

III. THE GROWTH OF SECTION 529 PLANS

Section 529 assets have grown rapidly since qualified distributions were made tax-free in 

2001. Between the fourth quarter of 2001 and 2007, total assets grew nearly nine-fold to 

$130 billion from $14 billion (see Figure 1). The collapse of asset prices in the latter part 

of 2008 caused total assets to fall 19 percent to $105 billion at year end. More recent 

data are not available, but total assets have undoubtedly risen in tandem with the stock 

market (the total return on the S&P500 was 14 percent between 12/31/2008 and 

8/28/2009). 

 

4

 Alexander and Luna (2009). 
4

At the end of 2008, about 88 percent of Section 529 assets were in savings plans and 12 

percent were in prepaid plans. Those shares at the end of 2001 were 82 percent and 18 

percent, respectively. 

IV. QUANTIFYING THE TAX BENEFITS OF SECTION 529 PLANS 

The tax benefits of Section 529 plans are similar to those of a Roth IRA. Savings are 

financed with after-tax dollars, and investment returns and distributions are untaxed if 

used to finance qualified education expenses. Relative to saving for college in an 

ordinary investment account, the benefits of this tax treatment depend on the taxpayer’s 

tax rates and the extent to which an ordinary taxed account yields interest, which is taxed 

at ordinary income tax rates, as opposed to dividends and capital gains, which are taxed 

at lower rates. 

To illustrate the tax benefits of Section 529 plans, the amount of future real college 

expenses that can be financed with a given amount of savings will be compared for the 

case where the saving is done in an ordinary taxed account and where it is done in a 

Section 529 account. For this illustration, it is assumed that annual pretax investment 

returns are 6.5 percent (4 percent real), and that the breakdown of pretax returns is 40 

percent interest, 24 percent qualified dividends, and 36 percent qualified capital gains. 

An initial $1,000 investment is assumed to accumulate for a set number of years before 

four annual distributions are taken that exhaust the account and that, after taxes are paid, 

finance a constant real amount of college expenses. During the account’s accumulation 

phase, it is assumed that asset reallocation results in 10 percent of capital gains earned 

each year to be realized and subject to capital gains tax. During the four-year payout 

phase, capital gains realizations subject to tax are entirely due to asset sales financing 

college expenses. 

The comparisons depend importantly on the account owners’ tax rates. Three different 

sets of assumptions are considered, each corresponding to a different level of income. 

The tax rates assumed are shown in Table 2. 

Because the comparisons assume that all account types earn the same pre-tax return, they 

reveal only relative tax benefits of Section 529 plans. Other factors might influence the 

relative after-tax returns earned in taxed accounts and Section 529 accounts. One such 

factor is account management fees, which are analyzed in Section VIII. 

The comparisons reported in Table 3 show that Section 529 savings plans potentially 

offer very substantial tax benefits. Consider, for example, the last row of the table that 

concerns a high income person and a 15 year accumulation period. Under the 

assumptions stated, $1,000 contributed to a fully taxed account in Year 1 would finance 

$1,465 of real college expenditures if taken in four equal annual installments beginning in 

in year 16 (see column 2). If the $1,000 were instead invested in a Section 529 account 

not receiving a state tax deduction, the real expenditures the investment would finance 

during college would increase 30 percent to $1,908 (see columns 3 and 6). With a state 
5

tax deduction for Section 529 contributions, the Section 529 account would finance $122 

more real college expenses ($2,030 total), or 39 percent more than would be financed by 

a taxed account. 

Table 3 shows that the tax benefits of Section 529 accounts increases with income and 

with the length of the accumulation period. Higher income means higher tax rates apply 

to the taxed account, which increases the value of earning tax free returns. And the 

benefit of tax-free returns relative to taxed returns is of course larger the longer the 

money is invested. Relative to a taxed account, the incremental value a Section 529 

account without a state tax deduction for contributions varies from 6 percent for the low 

income person and a 5 year accumulation phase to 30 percent for the high income person 

and a 15 year accumulation phase. In the case of a Section 529 account with a state tax 

deduction, the incremental value ranges from 13 percent to 39 percent. 

As has been noted, distributions from Section 529 plans are tax free only if they finance 

qualified education expenses of the beneficiary. In the alternative case, distributions are 

taxed to the extent that they represent account earnings, and those earnings are taxed as 

ordinary income to the recipient (either the account owner or the beneficiary), and in 

addition a penalty tax is imposed at the rate of 10 percent. Columns 5, 8, and 9 of Table 3 

concern this possibility. In the case of the low income earner and a 5 year accumulation 

phase, for example, the constant real expenditure the account can finance in years 6-10 is 

reduced 5 percent relative to a taxed account (see column 8). 

When the tax penalty for “nonqualified distributions” is expressed as a percent of the 

value of a taxed account as in column 8 of Table 3, it rises with income. This is because 

the absolute tax penalty—the numerator—tends to rise with income, and the value of a 

taxed account—the denominator—declines with income. The absolute tax penalty tends 

to rise with income because it depends on the difference between the ordinary income tax 

rate (the only tax rate that matters in the tax penalty case) and the tax rate on qualified 

dividends and capital gains that are germane in the case of a taxed account—a difference 

that tends to rise with income.5 6

Parents not certain their child will go to college and deciding whether to open a Section 

529 savings account must weigh the advantage of the account if the child goes to college 

against the disadvantage if the child does not go to college. One way of thinking about 

the decision is in terms of the expected value of the account, which is the gain if the child 

 

5

 The penalty for using Section 529 account monies for purposes other than to finance qualified education 

expenses is not entirely due to the 10 percent penalty rate. Relative to taxed account, a penalty account gets 

the advantage of deferring all taxes until money is withdrawn, but all earnings are taxed at the ordinary 

income tax rate (even if the accrue in the form of dividends and capital gains that ordinarily have relatively 

low tax rates). For the cases illustrated, there would be a penalty on net even if a 10 percent penalty rate 

were not imposed. 

6

 It is perhaps surprising that the column 8 entries increase with the length of the accumulation phase. 

Taxes are entirely deferred in the penalty case, and one might think that the tax penalty gets less severe the 

longer taxes are deferred. But taxes are also partly deferred in the ordinary tax case, and tax rates are lower. 

As a result, the column 8 entry initially rises with the accumulation phase length before ultimately 

declining. 
6

goes to college times the probability of the child going to college minus the loss if the 

child does not go to college times the probability of that occurring. For example, in the 

case of a low income individual and a 10 year accumulation period, the potential gain 

from a Section 529 account—the difference between column 2 and 3 of the table—is 

$145 of real spending during college, and the loss if the child does not go to college—the 

difference between columns 5 and 2, is $100 of real spending during college. In this case, 

the expected value of the Section 529 account is zero or positive if the probability of the 

child not going to college is 59 percent or less (0.59 x $100 = 0.41 x $145). This breakeven probability of taking nonqualified distributions from the account and incurring a 

penalty is shown in column (9) of the table. The breakeven probability tends to rise with 

income, meaning that the penalty for nonqualified distributions is more onerous, other 

things equal, the lower is the account owners income and tax rates. There is a slight 

exception between the medium and high income individuals. Continuing with the case of 

a 10 year accumulation period, the break-even penalty probability is 59 percent, 71 

percent, and 68 percent for the low, medium, and high income individuals, respectively. 

This measure is lower for the high income individual than for the medium income 

individual because those two individuals differ only with regard to the tax rate on 

ordinary income (they face the same tax rates on qualified dividends and capital gains), 

and that tax rate is more important for the absolute tax penalty than it is for the potential 

gain from a Section 529 account. 

The Table 3 illustrations do not incorporate the matching grants some states provide for 

certain Section 529 account holders. Currently, ten states progressively matching 

contributions of low and middle income families. As shown in Table 4, the Louisiana 

grants are at relatively low rates but are uncapped, and those of the other nine states are at 

higher rates but with caps that range from $200 to $1,000 per year. Section 529 plans are 

especially attractive to families qualifying for matching contributions provided they are 

confident they will have qualifying educational expenses to finance. 

V. OTHER TAX-PREFERRED VEHICLES FOR COLLEGE SAVINGS

Section 529 plans are one of several tax-preferred options households have to save for 

college, and this section compares them to other existing alternatives. 

Coverdell Educational Savings Accounts 

A Coverdell Educational Savings Account (ESA) offers the same federal tax benefits as 

does a Section 529 account. Contributions are made out of after-tax income, investment 

earnings are untaxed, and withdrawals are untaxed if used for a special Coverdell 

definition of qualified educational expenses. Notable differences between Coverdell 

ESAs and Section 529 plans include: 

• Annual Coverdell contributions cannot exceed $2,000 for any one beneficiary 

(aggregated across accounts), and the amount that can be contributed by any one 

contributor is also limited. The limit on an unmarried contributor’s contribution 

is $2,000 if modified adjusted gross income (MAGI) is less than $95,000, and is 
7

gradually reduced to zero for modified adjusted gross income between $95,000 

and $110,000. The modified adjusted gross income thresholds are doubled for 

married taxpayers filing jointly. 

• Coverdell qualified education expenses include certain expenses for elementary 

and secondary education. 

• The Coverdell ESA is necessarily owned by the beneficiary, in contrast to 

Section 529 accounts, which do not require the account owner and beneficiary to 

be the same person. If a Coverdell owner is a minor, a parent or guardian must be 

appointed the “responsible individual” who makes investment decisions, but that 

person can take distributions only to pay for the beneficiary’s qualified 

educational expenses. The beneficiary or “responsible individual” can designate 

another family member as beneficiary. 

Education Savings Bonds 

Educations savings bonds (ESBs) are series EE and Series I U.S. Treasury bonds. 

Interest on these bonds is untaxed by state and local governments and, if the taxpayer 

satisfies certain income requirements at the time of redemption, is also untaxed by the 

federal government and to the extent that the bond redemption proceeds are used to 

finance qualified higher education expenses. Qualified educational expenses exclude 

room and board. In 2009, the interest exclusion was phased out for modified adjusted 

gross income (MAGI) between $100,650 and $130,650 if married filing jointly, and for 

MAGI between $67,100 and $82,100 if single. 

To the extent that redemptions of ESB interest are excluded from tax, aside from a 

possible state tax deductions or credits for Section 529 contributions, the tax benefits of 

these bonds are the same as for Section 529 accounts. However, Section 529 accounts 

have two major advantages over ESBs: They offer much more flexibility in the range of 

investment options that are available (this is documented in Section VIII), and they 

potentially reduce student financial aid less than ESBs. Regarding student financial aid, 

ESB interest raises the “expected family contribution” (EFC) to a child’s educational 

expenses, whereas Section 529 earnings and distributions have no effect on the EFC. 

Individual Retirement Accounts 

Normally distributions from Individual Retirement Accounts (IRAs) are subject to a 

penalty tax if taken prior to age 59-1/2. An exception to this rule occurs when the 

distributions are used to finance qualified educational expenses that are defined the same 

as for Section 529 plans. 

IRAs are usefully divided into three types, traditional IRAs for which contributions are 

deductible and distributions wholly taxed at ordinary income tax rates when taken 

(deductible traditional IRAs), Roth IRAs for which contributions are made with after-tax 

dollars and all distributions are untaxed, and traditional IRAs for which contributions are 

not deducted and the earnings portion of distributions are taxed at ordinary income tax 
8

rates when taken (non-deductible traditional IRAs).7

 The general annual contribution 

limit for IRAs is $5,000 ($6,000 if age 50 or older). Lower limits can apply as is 

discussed below. 

The tax advantages of financing educational expenses with a Roth IRA are identical to 

that of a Section 529 account provided the amount withdrawn does not exceed total 

contributions. In that case, after tax dollars are contributed and withdrawals are entirely 

untaxed. (The earnings accumulated in a Roth IRA must be withdrawn after Age 59-1/2 

to escape taxation.) 

The tax advantages are quantitatively the same in the case of deductible traditional IRA 

provided the taxpayer’s income tax rate is the same at the time contributions are made as 

at the time distributions are taken. For example, consider a taxpayer with a 25 percent 

tax rate at all times. That taxpayer might contribute $750 to a Roth IRA that doubles in 

value over ten years to $1,500, and the entire balance would be available to finance 

college expenses. Alternatively, the taxpayer could invest $1,000 in a traditional 

deductible IRA and experience the exact same cash flows. At the time of the contribution, 

$1,000 would be invested but $250 of that is financed with the reduction in federal taxes 

that comes about because the $1,000 contribution deducts from taxable income. And 

after ten years, the account would be worth $2,000, 75 percent ($1,500) of which would 

be available to finance college expenses. 

Non-deductible traditional IRAs are a less tax favored means of financing college 

expenses than Section 529 plans. This type of IRA merely defers taxes on investment 

earnings rather than leaving them entirely untaxed as with a Section 529 plan. 

Deductible traditional IRAs and Roth IRAs are not available to everyone. The 

contribution limit for a deductible traditional IRA is the general limit for someone 

without an employer provided pension plan. For others, the annual contribution 

maximum starts at the general limit and is reduced gradually to zero for modified 

adjusted gross income (MAGI) between $55,000 and $65,000 (single) and $89,000 and 

$109,000 (married filing jointly). The Roth contribution limits are a limit that would 

apply if the taxpayer does not contribute to a traditional IRA (the Roth-only limit) less 

the amount contributed to a deductible and non-deductible traditional IRAs. The Rothonly limit is the general limit for someone without an employer provided pension plan. 

For others, the limit is the general limit gradually reduced to zero for MAGI between 

$105,000 and $120,000 (single) and $166,000 and $176,000 (married). 

The contribution limit for non-deductible traditional IRAs is the general limit less 

amounts contributed to deductible traditional IRAs. 

 

7

 Technically there are just two types of IRAs, traditional IRAs and Roth IRAs. A traditional IRA account 

can receive both deductible and non-deductible contributions, and the division between the two types of 

contributions is kept track of via the basis calculation. To simplify the exposition, this discussion imagines 

an IRA account that is 100 percent funded either with deductible contributions or with non-deductible 

contributions. 
9

A major advantage of IRAs over Section 529 plans is that withdrawals can be taken 

without penalty for any reason after age 59-1/2. A parent therefore does not risk being 

penalized in the event that their child incurs fewer qualified educational expenses than 

expected. 

However, saving for college in an IRA is much more likely to reduce a student’s financial 

aid than is saving in a Section 529 account. IRA distributions raise the “expected family 

contribution” (EFC), whereas Section 529 distributions have no effect on the EFC. On 

the other hand, Section 529 account assets raise the EFC while IRA assets have no effect 

on the EFC. On balance, for families with income not so low that their EFC is negative, 

or so high that their EFC exceeds the cost of college attendance, the IRA reduces 

financial aid over four years of college much more than does a same-size Section 529 

account. 

VI. THE DISTRIBUTION OF SECTION 529 TAX BENEFITS

This section first examines how participation in Section 529 plans vary with household 

income, and concludes that existing data—while limited—suggest that Section 529 

usage is highly skewed toward higher income groups. Approaches to better target 

Section 529 benefits to the middle class are then considered. 

A. THE EMPIRICAL EVIDENCE

Participation in Section 529 plans is likely to increase with income for three principal 

reasons. First, the tax benefits of a Section 529 plan increase with a family’s tax rate, 

which increases with their annual income. Second, the savings rate in general increases 

with income as wealthier households need to spend a smaller share of their income on 

necessities such as food and rent. Finally, the likelihood of a child attending college 

increases with family income. 

Data relating Section 529 participation to income is limited because plan administrators 

generally have no need for it. Treasury was able to obtain such information from only 

two states, Lousiana and Kansas. Treasury also analyzed data from the 2007 Survey of 

Consumer Finances (SCF), which is collected by the Federal Reserve Board. 

Each of these datasets has its weaknesses. The Louisiana and Kansas data are likely to be 

highly accurate because they draw from actual administrative records, but may not be 

representative of all plans across the country. The SCF data are for a national sample, but 

the sample size is relatively small and responses are probably subject to substantial 

measurement error as they rely on individual self-reports of income and assets. 

For our purposes, the best of these three data sources may be Louisiana. Louisiana offers 

progressive matching contributions at rates ranging from 14 percent for families with 

federal adjusted gross income (AGI) less than $30,000 to 2 percent for families with AGI 

greater than $100,000. Because the plan administrator verifies the AGI of account 

contributors in order to determine the state’s matching contribution, it can tabulate 
10

average account balances by AGI class as is done in Table 5. The table shows that 

Louisiana Section 529 account balances are substantially more skewed toward high 

income families than is income. In 2008, Louisiana taxpayers with 2007 federal AGI in 

excess of $200,000 accounted for 2 percent of Louisiana tax returns and 22 percent of 

Louisiana federal AGI, but fully 42 percent of Louisiana Section 529 account balances. 

For taxpayers with federal AGI $100,000 and higher, the shares were 9 percent of returns, 

43 percent of federal AGI, and 72 percent of Section 529 account balances. 

The Louisiana data also demonstrate that Section 529 participation rates rise rapidly with 

income. Relative participation rates can be inferred by comparing the share of tax returns 

and the share of accounts falling into each AGI category. For example, taxpayers with 

federal AGI less than $100,000 account for 91 percent of taxpayers and 54 percent of 

accounts, while taxpayers with AGI greater than $100,000 account for 9 percent of 

taxpayers and 46 percent of accounts, meaning that the participation rate is about 9 times 

higher for the higher income group than the lower income group. Nevertheless, it is 

noteworthy that taxpayers with federal AGI less than $100,000 account for over half of 

Louisiana’s Section 529 accounts. 

Data from the Kansas Department of Revenue shown in Table 6 are similar to the 

Louisiana data except that they concern Section 529 contributions rather than account 

balances. Kansas offers a state income tax deduction for Section 529 contributions that is 

capped at $3,000 per beneficiary for a single taxpayer and $6,000 per beneficiary for a 

married couple filing jointly. The table shows Section 529 contributions deducted from 

2007 Kansas taxable income by 2007 federal AGI category. Taxpayers with AGI in 

excess of $250,000 accounted for 1 percent of Kansas tax returns, 17 percent of federal 

AGI in Kansas, 18 percent of taxpayers claiming a Section 529 deduction, and 37 percent 

of deducted contributions. And for taxpayers with federal AGI $100,000 and higher, the 

shares were 11 percent of returns, 46 percent of federal AGI, 63 percent of taxpayers 

claiming a deduction, and 81 percent of deductions for Section 529 contributions. 

Comparing the above $100,000 findings to the Louisiana findings, it appears that 

deducted contributions in Kansas are somewhat more skewed toward high income 

taxpayers than are total Section 529 balances in Louisiana. But Kansas caps these 

deducted contributions at relatively low levels, so it is possible that total (uncapped) 

contributions in Kansas are even more skewed toward high income taxpayers than are 

account balances in Louisiana. 

Another source of information on the distribution of Section 529 account balances by 

income is the Survey of Consumer Finances (SCF), which is summarized in Table 7. 

This dataset suffers from a small sample size and probably substantial measurement error 

relative to state administrative data because it requires subjects to self-report income and 

asset information. 

While the SCF asked households about Section 529 accounts, the public database does 

not distinguish between a Section 529 account and a Coverdell ESA account. Hence the 

table concerns the aggregate of those two account types. The inclusion of Coverdell 
11

ESAs almost certainly causes account balances and participation to be more equal across 

income groups due to the low Coverdell ESA contribution limits. 

The top part of Table 7 reports the percent of survey households with children that report 

having a Section 529/Coverdell account for six income groups: the 1st, 2nd, and 3rd

income quartiles, and the top quartile subdivided into the 75-90th percentile range, the 90-

95th percentile range, and the 95-100 percentile range. Participation grows rapidly from 

less than 1 percent in the lower half of the income distribution to over 30 percent in the 

95-100 income percentile range. The standard errors reported below the estimates 

indicate that the differences are statistically significant. 

The lower part of Table 7 concerns account balances for households with children who 

report having a Section 529/Coverdell account. It shows that average account balances 

also rise rapidly with income. The average account balance is about $8,000 in the 0-75 

percentile group, about $15,000 in the 75-90 percentile group, about $30,000 in the 90-95 

percentile group, and over $100,000 in the 95-100 percentile group. While these 

averages have high standard errors, the differences are statistically significant between 

each of the top three groups. 

The SCF data suggest that account balances tend to rise with income in a manner 

consistent with the Louisiana and Kansas data. Account balances as a percent of income 

average about 10 percent in the 0-75 percentile group, about 13 percent in the 75-90 

percentile group, about 16 percent in the 90-95 percentile group, and about 25 percent the 

95-100 percentile group. But high standard errors indicate that the estimates are 

imprecise. 

B. APPROACHES TO BETTER TARGET SECTION 529 BENEFITS TO MIDDLE 

 CLASS FAMILIES

Make Section 529 Contribution Limits Per Beneficiary 

Section 529 savings plans are required to provide safeguards to prevent contributions on 

behalf of the designated beneficiary to exceed what is necessary to finance the qualified 

education expenses of the beneficiary. States offering savings plans satisfy this 

requirement by refusing contributions to accounts once the account balance exceeds a 

certain dollar limit. Most states base their limit on the cost of four years of undergraduate 

education and three years of graduate education, an approach sanctioned in an IRS 

private letter ruling to the New York State Section 529 savings program. As a result the 

limits are very high, varying between $224,465 and $368,600, and exceeding $300,000 in 

29 states. Moreover, these limits are per beneficiary per state. Because 43 of the 48 states 

offering a Section 529 savings plans are open to non-residents, a particular beneficiary 

can have accounts in as many as 44 states, each with a contribution limit of $224,465 or 

more. In effect, there is currently no limit on Section 529 contributions. 

Putting a true limit on Section 529 contributions requires making the limits per 

beneficiary rather than per beneficiary per state. Per beneficiary limits would reduce the 
12

tax benefits to high income families and, by lowering federal tax expenditures for the 

program, would potentially free up federal resources for education aid better targeted to 

low and middle income families. 

The current contribution limits are based on the account balance at the time a contribution 

is made, an approach that would be very difficult to administer if a beneficiary has 

accounts in more than one state and the limit were per beneficiary. A per beneficiary 

limit would be more workable if the limit were imposed on total contributions and if the 

limit were enforced at the time distributions are made. In such a scheme, each 

distribution for a particular beneficiary’s qualified educational expenses would be divided 

into a principle portion counting against the contribution limit and an earnings portion. 

At such time as a beneficiary reaches the contribution limit, distributions would be 

deemed nonqualified and subject to penalty. 

State Matching Grants 

Grants progressively matching Section 529 contributions are a promising means of 

increasing Section 529 savings plan participation of lower income families. Ten states 

offer such grants (Table 4). Those states’ experiences could be instructive to other state 

plans. 

VIII. SECTION 529 SAVINGS ACCOUNT INVESTMENT OPTIONS AND FEES

While Section 529 plans are overseen by the states, all except five states contract out all 

or most of the management and recordkeeping functions to financial services companies, 

and all states contract out investment management services to financial services 

companies. Service providers are presumably selected based on their proposals for 

investment options, services provided, and fees charged, as well as their reputations for 

quality service. 

Section 529 savings plans are of two general types—advisor sold plans offered through 

financial advisors, and direct sold plans that allow individuals to sign up and select 

investment options via the internet without the aid of a financial advisor. For advisor 

sold plans, fees include periodic charges levied as a percent of account balances, “loads” 

levied either as a percent of asset purchases (front-load fees) or asset sales (back-load 

fees), and fixed-dollar annual account maintenance fees that are generally $50 or less. 

Direct sold plans assess only periodic charges on account balances and possibly annual 

maintenance fees; they do not impose load fees on purchases or sales. Advisor sold plan 

fees include compensation for the advisors, which contributes to fees being higher for 

advisor sold plans that for direct sold plans. Currently 48 states offer direct sold plans—

all except Tennessee, Washington, and Wyoming—and 27 states of those states also offer 

advisor sold plans. (Tennessee and Washington offer only prepaid plans, and Wyoming 

has partnered with Colorado’s plan.) 

Section 529 savings plans tend to offer a variety of investment options that accommodate 

a wide range of tastes concerning the tradeoff between risk and expected return. The 
13

investment options are almost always retail mutual funds offered to the general public, or 

combinations of such funds. Fees are higher than for the underlying retail funds because 

they include a program manager fee and most often a state fee as well. 

The most popular Section 529 investment option is an age-based fund with an asset mix 

that is heavily weighted toward equities when the beneficiary is young but automatically 

becomes more weighted toward fixed income assets as the beneficiary approaches 

college age. The idea is that equities are very likely to outperform fixed income 

investments over a period of many years, so it is prudent to have a high exposure to 

equities when the investment horizon is long, but if the money is needed soon, it is best to 

have a more conservative portfolio that offers better principle protection. Forty-nine of 

the 55 direct sold plans, and 25 of the 31 advisor sold plans, offer age-based options (see 

Table 8). More than half of these plans offer more than one age-based option with 

varying degrees of risk. Vanguard reports that 60 percent of assets in six Section 529 

plans supported by Vanguard’s full services were in age-based funds at the end of 2008.8

 

Age-based funds for Section 529 plans are similar to target retirement date funds. The 

essential difference is that the asset composition of target retirement date funds is gauged 

to time to retirement whereas the asset composition of Section 529 age-based funds are 

gauged to time to the beneficiary’s freshman year of college. The logic of target date 

retirement funds can be compelling; the potential for making up investment losses by 

working and saving more becomes less and less as the investor approaches retirement age, 

so it makes good sense for a worker’s overall investment portfolio to become more 

conservative as the retirement date approaches. To the extent that a Section 529 account 

comprises a large portion of an investor’s overall portfolio, this asset rebalancing must be 

done in the Section 529 account and an age-based fund is especially appropriate. 

Otherwise, the Section 529 account could have a static investment allocation and asset 

rebalancing could be done other parts of the investor’s portfolio. 

Also, to the extent that the interest rate on loans exceeds the risk-free return that can be 

earned on investments, parents have an especially strong interest in avoiding the 

necessity of borrowing to finance a child’s education. This consideration argues for an 

overall investment portfolio that is gauged to the date a child enters college, not the date 

the parent retires. The idea, once again, is that the possibilities for making up investment 

losses by working and saving more so as to avoid the necessity of borrowing becomes 

less and less as the child approaches college age. In this case, of course, an age-based 

Section 529 fund is appropriate. 

Section 529 plans also accommodate investors who wish to build a customized portfolio. 

Table 8 shows that the number of investment options averages 11 for direct sold plans 

and 18 for advisor sold plans. More than three-quarters of plans offer each of the five 

option types shown in Table 8: Age-based funds, blended (balanced) funds, pure equity 

funds, pure fixed income funds, and money market funds. About half of the plans offer 

all five options types. Table 8 also reports investment options by state, which differs 

 

8

 This data was submitted by Vanguard in a letter responding to Treasury’s Federal Registry request for 

information,. 
14

from the by-plan numbers because some states offer more than one plan. Five states 

offering a direct sold plan do not offer an age-based option. 

Account Fees for Section 529 Direct Sold Plans 

Table 9 reports the distribution of account fees for 57 direct-sold moderate-risk age-based 

funds for a 5 year old beneficiary. These funds are chosen for analysis because nearly all 

plans offer them and they are popular with investors. Of the 57 funds, 24 are entirely or 

almost entirely made up of index funds. Index funds are passively managed so as to 

mirror the performance of a specific asset bundle, such as the 500 stocks making up the 

S&P 500 index. Since portfolio decisions are automatic and transactions are infrequent, 

expenses tend to be lower than those of actively managed funds. 

As is true for all direct-sold funds, fees for the age-based funds include periodic 

assessments levied as a percent of account balances (asset-based fees) and possibility a 

small fixed dollar account maintenance fee. Because the annual maintenance fees are 

generally $25 or less, and are often waived for home state residents and for high-balance 

accounts, annual maintenance fees are not considered in the table. Asset based fees are 

typically expressed as annual expenses divided by average annual net asset value, which 

is referred to as the expense ratio. 

Table 9 shows that there is substantial variation in fees across the 57 age-based funds 

analyzed. The expense ratio varies from 0.24 percent to 1.30 percent, and averages 0.78 

percent. For the 24 index funds, the range is 0.24 percent to 1.03 percent, and the mean 

is 0.61 percent. Twenty of the 24 index funds have expense ratios in the lower half of the 

distribution for all 57 funds. Of the other four index funds, two have especially high 

program manager fees, and two have surprisingly high fees for the underlying mutual 

fund. 

The middle three columns of Table 9 reports the implications of the asset-based fees for 

the amount of saving that must be done to finance a given amount of college expenses. 

For a particular time pattern of account contributions, those columns of the table express 

fees as a percent of contributions made—that is, they report the equivalent front-load fee 

in percentage terms. For example, if fees are equivalent to 5 percent of contributions 

made, fees increase the amount of saving that must be done to achieve a given target 

account value by 5 percent. The estimates assume 17 years of monthly account 

contributions sufficient to fund 4 years of college expenses beginning 14 years in the 

future if there are no account fees, real annual college costs growth 2 percent annually 

from a current level of $11,000, and annual returns before fees are 7.0 percent in nominal 

terms and 4.5 percent in real terms. In this case, the table shows that the equivalent frontload fee ranges from 2.2 percent to 11.2 percent, and averages 6.9 percent. 

The last three columns of Table 9 give further perspective on the magnitude of Section 

529 fees for direct-sold plans. It gives the percent of real account investment earnings 

that are absorbed by fees for the same scenario that underlies the calculations of the 
15

equivalent front-load fee. For all 57 funds, this real return absorption measure ranges 

from 6.9 percent to 35.2 percent, and averages 21.6 percent. 

Assessing the reasonableness of Section 529 fees for actively managed funds is difficult 

because some of the fees compensate investment strategists with varying reputations and 

levels of talent.9

 But the large variance in fees levied for index funds does suggest that 

there is wide variation in the efficiency of Section 529 plan administration. While the 

index funds analyzed do not all share the same asset composition targets, and hence 

should not be expected to have precisely the same fees, the underlying investment 

management costs undoubtedly vary much less than do the fees. The residual fee 

variance must reflect cross-subsidies between fees levied for actively managed funds and 

index funds, variance in plan administrative efficiency, or both. 

It is surprising that five states with a direct sold plan do not offer an age-based plan, and 

only 23 of the 43 states that do offer an age-based plan offer an index fund. (Table 9 

shows 24 index funds, but two of those are offered by a Kansas plan.) Index funds have 

two major advantages over actively managed funds. First, because of their low fees, they 

on average perform well relative to actively managed funds and have a large following in 

the investment community.10 Second, they are well suited to investors who do not wish 

to spend time acquiring information and evaluating the investment philosophy and track 

records of the various actively managed funds that are offered. 

Account Fees for Section 529 Advisor Sold Plans 

Table 10 demonstrates that Section 529 account fees are much higher for advisor sold 

plans than for direct sold plans. The table shows the fee distribution for 29 moderate risk 

age-based plans for a 5-year-old that are currently offered by advisor plans, none of 

which are index funds. Account fees taken into account include asset-based fees and 

front-load fees levied on asset purchases. In order to combine these two types of fees 

into the equivalent front-load fee, it is necessary to assume a particular scenario for 

account contributions. That scenario is the same as was assumed for the calculations 

underlying Table 9--17 years of monthly account contributions are made that are 

sufficient to fund 4 years of college expenses beginning 14 years in the future if there are 

no account fees, real annual college costs growth 2 percent annually from a current level 

of $11,000, and annual returns before fees are 7.0 percent in nominal terms and 4.5 

percent in real terms. In this scenario, the equivalent front-load fee averages 15.2 percent, 

 

9

 The distribution of fees for actively managed funds in Table 9 is not greatly different than the distribution 

of fees for similar retail mutual funds. Fee information on 15 no-load actively managed target retirement 

date 2020 and 2025 funds obtained from Morningstar indicates a fee distribution similar to that of the 33 

actively managed age-based funds analyzed in Table 9. However, it could be argued that states should be 

better at weeding out low-value funds than are investors generally. 

10 Over the five years ending June 30, 2009, only 41 percent of actively managed domestic equity funds 

analyzed by Standard and Poor’s outperformed their benchmark index. However, when weighted by assets 

managed, actively managed funds outperformed their benchmark in all categories except midcaps and 

emerging markets. Standard and Poor’s Indices Versus Active Funds Scorecard, Midyear 2009, 

http://www2.standardandpoors.com/spf/pdf/index/SPIVA_2009_Midyear.pdf 
16

nearly twice the average for direct sold actively managed funds of the same type. The 

equivalent front load fee range is 12.3 percent to 17.9 percent. 

As is true for direct-sold actively managed funds, advisor sold actively managed funds 

vary in quality and the reasonableness of their fees is therefore difficult to assess. What 

can be said is that the distribution of fees shown in Table 10 is not greatly different than 

fees in similar retail mutual funds with front loads. This inference is based on fee 

information on 45 front-load actively managed target retirement date 2020 and 2025 

funds obtained from Morningstar.11

Home-State Bias in State Tax Policies and Investment Management Fees 

There is widespread agreement that Section 529 fees have come down rapidly in recent 

years in part because of increased competition between plans.12 However, the wide 

variation in fees levied for essentially the same index funds suggests that competition is 

currently imperfect and more competition would be desirable. The essential benefit of 

competitive markets is that they squeeze out inefficiency and result in lower prices for 

consumers. 

A major impediment to competition between Section 529 plans is home-state bias in state 

tax policies. Currently 34 of the 42 states that both have an income tax and sponsor 

Section 529 savings plans offer either a state income tax deduction or a credit for 

contributions to their own Section 529 plan, but only five of those states offer a deduction 

for contributions to Section 529 plans sponsored by other states (see Table 1). In addition, 

13 states exclude all or some Section 529 account balances from assets for purposes of 

calculating eligibility for state student financial aid, but none of those states offer a 

similar exclusion for the Section 529 account balances held in the plans of other states. 

As a result of this home-state bias, families have strong incentives to choose their home 

state plan even if other plans offer preferable investment choices. Some families may be 

deterred from even investigating other plans under the possibly false assumption that the 

state tax benefits of choosing the home plan necessarily outweigh any possible 

advantages other plans might offer. 

If these barriers to competition were eliminated, the result would be more investment 

options for consumers, more intense competition between plans, and lower fees. To the 

extent that there are economies of scale in plan administration, some state plans might be 

forced out of the market entirely so that remaining plans can benefit from additional scale 

and lower costs. Such exit from the industry would contribute to lower fees and would 

benefit consumers. 

 

11 This data was provided in response to Treasury’s request for fee information for the largest 2020 and 

2025 target date funds. 

12 It would be very difficult to determine empirically the extent to which inter plan competition as opposed 

to other factor have brought down Section 529 fees. Industry observers tend to think competition is an 

important factor. For example, Capital Research and Management, the program manager for Virginia’s 

advisor sold plan, the single largest Section 529 savings plan, wrote the following in a letter responding to 

Treasury’s Federal Register request for information: “As 529 plans have become more broadly available 

and have attained reasonable scale, competition has promoted lower 529 plan fee structures.” 
17

Home-state bias in state tax policies not only reduces competition, it is unfair. A state tax 

deduction or credit for Section 529 contributions lowers the net tax burden of individuals 

receiving the deduction or credit, and it raises the net tax burden of other state residents. 

Three groups of state residents are pertinent: Section 529 participants in the home state 

plan, participants in other state plans, and non-participants. While it might reasonably be 

decided that non-participants should subsidize participants, there would seem to be no 

compelling reason why residents choosing to invest in other states’ Section 529 plans 

should subsidize residents who choose the home state plan. Relative to a discriminating 

regime, it would be more equitable to offer financial incentives to all residents 

participating in Section 529 plans and scale back the incentive so that the 

credit/deduction is no more costly than in the discriminating regime. 

It is often argued that states cannot afford the additional revenue losses that would result 

from extending their current deduction or credit to participants in other state plans. But 

that is not the pertinent policy question; the pertinent policy question is whether or not it 

is better to give a large tax incentive to residents participating in the home state plan, or a 

smaller and equally costly incentive to residents participating in any plan. 

Another justification for home-state bias in state tax policies that is often given is that 

scholarships and matching grants for low income residents are often financed out of 

Section 529 fees, and that it would be unreasonable to expect a state to encourage its 

residents to pay other states’ fees that subsidize similar expenditures for other states’ 

residents only. However, to the extent this is true, states have the option to instead 

finance education subsidies for low income residents out of general revenues and to 

lower Section 529 plan fees accordingly. There seems to be no compelling reason why 

education subsidies for low income residents should be financed with higher fees 

imposed on Section 529 plan participants rather than by taxpayers generally. 

IX. PREPAID TUITION PLANS

Section 529 savings plans and Section 529 prepaid tuition plans are different means of 

saving for future college expenses. Most Section 529 plan beneficiaries have either one 

or the other type of plan, but there is no reason why the two types of plans can’t be 

combined. 

In a prepaid tuition plan, tuition credits or certificates are purchased on behalf of a 

beneficiary that entitle the beneficiary to a specified number of credit hours of future 

attendance at designated educational institutions, and the plan sponsor maintains a Trust 

that invests the prepayments and uses the proceeds to finance the tuition promised. 

Currently, 16 states operate such plans, but new enrollees are being accepted in just 13 of 

those plans. Table 11 lists prepaid plans and their features. 

Prepaid tuition plans are of three types. The most common is a “contract plan.” In 

contract plans, a set schedule of payments are made that entitle the beneficiary to a 

specified amount of future tuition and mandatory fees at in-state public colleges, 
18

universities, and community colleges. For example, one contract offered by the Alabama 

plan in 2008 called for 148 monthly payments in the amount of $262 beginning in 

February 2009 that entitle the beneficiary to 4 years of payouts beginning in the Fall of 

2021 that cover the weighted average of tuition and mandatory fees at all Alabama 4-year 

educational institutions. Contract plans provide for a variety of payout options and a 

variety of payment options. For example, the payout might be for only one year of 

college attendance, or the payment might be a single lump-sum payment. 

The second type of prepayment program is a “unit program.” For example, 100 units 

represents one year of tuition and mandatory fees at Washington State’s two flagship 

universities, the University and Washington (UW) and Washington State University 

(WSU) The unit price is revised once each year and is currently $101. Hence, $10,100 

would secure a payout in any future year toward the cost of qualified educational 

expenses equal to the cost of one year of attendance at the UW or WSU. The unit price is 

not necessarily the current cost of tuition; the current Washington State unit price is in 

fact 33 percent higher than current tuition, perhaps reflecting the expectation of steep 

future tuition price increases. Washington State also offers contract plans. 

The third type of prepaid tuition plan is a “voucher plan” that operates in much the same 

way as a unit plan. The difference is that in a voucher plan, participating educational 

institutions rather than a state sell vouchers for future attendance at their own institutions. 

Massachusetts is the only state with a voucher program. The Independent 529 plan, 

which is sponsored by non-profit consortium of 127 private colleges and Universities, is 

also a voucher plan. 

While payouts of prepaid plans are based on in-state tuition and fees, those payouts can 

be directed to private and out-of-state educational institutions. In two cases, however, the 

payouts might be smaller than if an “in-network” institution is attended. If a beneficiary 

attends an out-of-network school, the Virginia plan payout is the lesser of what it would 

pay if an in-state school was attended and the sum of prepayments made plus actual 

returns earned on those prepayments, and the Massachusetts plan payout is equal to 

prepayments made adjusted for price inflation. 

The state tax deductions and credits listed in Table 1 apply to all contributions made to 

Section 529 plans, regardless of whether they are to a savings plan or to a prepaid plan. 

Estimates of the Value of Prepaid Plans Relative to Savings Plans 

Whether it is preferable to make contributions to a prepaid plan or to make the same 

contributions to a savings plan depends on the future returns that will be earned in the 

savings account and the future cost of tuition and fees that will be financed with the 

savings account. For example, in the simple case of a prepaid program of the unit type 

where units are currently priced in accordance with current tuition costs, the savings plan 

would outperform the prepaid plan if the average nominal savings plan return exceeds the 

average annual growth rate of tuition. The comparison is more complicated if the prepaid 

plan’s current unit price is based on tuition prices greater than current tuition prices; in 
19

that case, the savings plan would not have to earn a return as high as annual rate of tuition 

increase in order to outperform the prepaid plan. 

It is important to distinguish the ex post value from the ex ante relative values of prepaid 

tuition plans and Section 529 savings plans. The ex post relative values are quantified 

below; they simply indicate the circumstances under which the investor does better with a 

prepaid plan than with a savings plan. The ex ante value includes the value of insurance; 

it is the expected ex post value plus a premium reflecting the value of knowing the price 

of future tuition now rather than later. Hence, in cases where the ex post value of a 

prepaid plan is equal to the value of a savings plan, the ex ante value of the prepaid plan 

exceeds the value of the savings plan by an amount that depends on the degree to which 

the investor is risk adverse. The value of insurance is not easily measured, but is 

important. 

For prepaid plans of the unit type, year to year unit price changes are entirely 

discretionary, and hence have no set relationship to actual changes in tuition prices. 

Hence, such plans cannot be easily compared with savings plans in the realistic case 

where a family purchases credits over a number of years. Contract plans, in contrast, do 

allow a family to commit to a set stream of monthly payments that secure a given number 

of semesters of schooling. The analysis that follows, therefore, is limited to contract 

plans. In particular, the ex post value of ten contract prepaid plans that are currently open 

to new enrollment will be compared to the ex post value of a generic Section 529 savings 

plan. 

The comparisons assume a family takes out an extended monthly-payment contract 

during the fall 2008 enrollment period to secure 4 years of University education for a 5-

year-old who is expected to enter college in the fall of 2021. For each of the ten contract 

plans, the information necessary to make the comparison is the monthly payment, the 

number of monthly payments, the date the first payment is due, and the 2008 level of 

tuition and fees corresponding to the tuition and fees future contract payouts are tied to. 

(For example, the payout might be tied to the weighted average of tuition and fees at instate 4-year public educational institutions.) In addition, to simplify the comparisons, it 

is assumed that the returns earned in a savings plan are constant between 2008 and the 

time of graduation (2024), and that annual tuition (and mandatory fee) growth in each of 

the years the child is attending school is the same as the average annual growth rate 

between 2008 and 2021. (In what follows, “tuition” is understood to include mandatory 

fees.) In this simple case, it is possible to determine whether a particular prepaid plan 

outperforms a saving plan based on two quantities—the average annual nominal return 

earned in the savings account, and the average annual growth rate of tuition. Other things 

equal, the relative value of the prepaid plan increases with the average growth rate of 

tuition, and decreases with the nominal return that can be earned in a Section 529 savings 

plan. 

While it would be possible to determine the relative value of a prepaid tuition plan and a 

savings plan for various assumptions for investment returns and tuition growth, assessing 

the likelihood of the various scenarios is complicated by the fact that each percentage 
20

point of expected general price inflation causes both nominal investment returns and 

tuition growth to increase by a percentage point. Hence, the basic assumptions that will 

be varied in the comparisons are: (1) the average rate of general price inflation, (2) 

average nominal investment returns in excess of general price inflation (the “real” 

investment return), and (3) average annual growth in tuition in excess of general price 

inflation (“real” tuition growth). 

Tables 12 and 13 show the results of the comparisons. First, consider Table 12. For each 

combination of assumptions for real investment returns and general price inflation, and 

for each of the ten prepaid plans, there is an annual growth rate for real tuition that makes 

the prepaid plan equal in value to a Section 529 savings plan ex post. This real tuition 

growth rate will be referred to as the threshold real tuition growth rate. The cell entries in 

Table 12 give the threshold real tuition growth rate averaged across the ten prepaid plans. 

This average ranges from 3.5 percent if real investment returns are 2 percent and general 

price inflation is 6 percent, to 7.5 percent if real investment returns are 6 percent and 

general price inflation is 2 percent. Tuition growth higher than these values makes the ex 

post value of prepaid plans on average greater than the ex post value of a savings plan, 

and tuition growth below these amounts makes the ex post value of prepaid plans on 

average greater than the ex post value of a savings plan. 

The six cells of Table 12 that are equal to or less than 4.5 percent are shaded to indicate 

that they are within the range of historical experience for sustained real tuition growth. 

This judgment is based on Figures 2 and 3. The first figure shows average real annual 

tuition at 4-year public Universities for each academic year between 1976/77 and 

2007/08. This average fell at a 1.7 percent rate between 1976/77 and 1981/82 before 

commencing a steady rise—growing at a 4.1 percent annual rate between 1981/82 and 

1999/00 and at a 4.5 percent rate between 1999/00 and 2007/08. Figure 3 gives the 

average annual real tuition growth for ten-year periods ending in the year shown. Only in 

two ten-year periods did annual rate of real tuition growth average more than 4.5 percent, 

the periods 1981/82-1991/92 and 1982/83-992/93. And the exceptional growth in those 

two periods is explained in large part by depressed beginning-of-period real tuition levels 

resulting from real tuition declines between 1976/77 and 1981/82. 

Table 12 concerns threshold real tuition growth rates averaged over ten plans. Table 13 

supplements that information by giving the share of the ten prepaid plans that 

outperforms a Section 529 savings plan if real annual tuition growth averages 4.5 percent. 

Only if real investment returns are 2 percent or less and general price inflation is 4 

percent or greater do more than half the plans outperform a Section 529 savings plan 

when real tuition growth averages 4.5 percent. 

X. CONCLUSION AND RECOMMENDATIONS

Section 529 plans are an attractive and convenient means of saving for college. Direct 

sold savings accounts in particular can be easy to set up and require minimal initial 

investments. And the tax benefits can be substantial; this paper’s illustrative calculations 

indicate that existing tax benefits can increase the effectiveness of saving by between 6 
21

percent and 39 percent depending on the marginal tax rates of the saver, the length of the 

savings period, and whether there is a state deduction or credit for contributions. 

While Section 529 plans offer tax benefits to any family with sufficient income to pay 

federal income tax, they are of greater benefit to high income families whose tax rates 

tend to be higher. This tax advantage is likely part of the reason why Section 529 

account balances tend to increase disproportionately with increases in income. Whether 

this is undesirable is debatable. It could be argued, for example, that the most effective 

way to help low income families with college expenses is through direct student aid, and 

that Section 529 plans are therefore naturally targeted to higher income families. It is for 

this reason that the report has focused on making Section 529 plans more accessible, 

effective and reliable for the middle class. 

This report has identified six approaches that we recommend that states and others 

consider implementing to make Section 529 savings plans more attractive, effective and 

reliable for middle class families, and those who aspire to join the middle class through 

college attendance. 

Recommendation 1: Provision of Age-Based Index Funds. Section 529 savings plans 

tend to offer a wide array of investment options that accommodate a variety of families’ 

tastes for risk and expected return. The most popular option, and one that is well suited 

to the circumstances of many families, is an age-based fund that automatically sheds 

equities and adds fixed income assets as the beneficiary approaches college age. Yet five 

of the 48 states offering a direct sold savings plans do not offer an age-based fund. 

Equally troubling is the fact that only 23 of the 43 states that do offer an age-based fund 

offer it in the form of index funds. Historically, index funds have performed well relative 

to actively managed funds because they have low fees, and they are especially well suited 

to investors who do not wish to spend time acquiring information and evaluating the 

investment philosophy and track records of actively managed funds. 

Recommendation 2: Eliminate Home-State Bias. There is widespread agreement that 

Section 529 fees have declined substantially in recent years, and that increased plan 

competition is in large part responsible. Yet there remains surprisingly large variance in 

fees assessed for similar age-based index funds offered by the 24 plans across 23 states, 

suggesting that inter-plan competition is far from perfect. While the index funds 

analyzed do not all share the same asset composition targets, and hence should not be 

expected to have precisely the same fees, fees appear to be higher than necessary in at 

least some states. 

A potentially important hindrance to inter-plan competition is home-state bias in state tax 

policies. Currently 34 of the 42 states that both have an income tax and sponsor Section 

529 savings plans offer either a deduction or a credit for contributions to their own 

Section 529 plan, but only five of those states—Arizona, Kansas, Maine, Missouri, and 

Pennsylvania—offer a deduction for contributions to Section 529 plans administered by 

other states. In addition, 13 states exclude all or some Section 529 account balances from 

assets for purposes of calculating eligibility for state student financial aid, but none of 
22

those states offer a similar exclusion for the Section 529 account balances held in the 

plans of other states. As a result of this home-state bias, families have strong incentives 

to choose their home state plan even if other plans offer preferable investment choices. 

Some families may be deterred from even investigating other plans under the possibly 

false assumption that the state tax benefits of choosing the home plan necessarily 

outweigh any possible advantages other plans might offer. If these barriers to 

competition were eliminated —as they are currently in five states — the result would be 

more investment options for consumers, more intense competition between plans, and 

probably better service and lower fees for many customers. 

Recommendation 3: Per Beneficiary Contribution Limits. Currently there are 

effectively no limits on Section 529 account balances. States offering savings plans 

refuse contributions to accounts once the account balance exceeds a dollar limit that 

varies between $224,465 and $368,600, and averages $291,000. Because 43 states offer 

plans open to residents in other states, however, a beneficiary can have accounts in as 

many as 44 states, each state with a limit exceeding $224,465. Putting a true limit on 

Section 529 contributions requires making the limits per beneficiary rather than per 

beneficiary per state. Per beneficiary limits would reduce the tax benefits to high income 

families and, by lowering federal tax expenditures for the program, would potentially free 

up federal resources for education aid better targeted to low and middle income families. 

Per beneficiary limits would best be enforced at the time distributions are made. 

Specifically, each distribution for a particular beneficiary’s qualified educational 

expenses would be divided into a principle portion counting against the contribution limit 

and an earnings portion. At such time as a beneficiary reaches the contribution limit, 

distributions would be nonqualified and subject to penalty. 

Recommendation 4: Improved Transparency. The College Savings Plan Network 

(CSPN) has done a valuable service by collecting information on Section 529 savings 

plans and making it available in a convenient form on the internet. However, because 

there is no established format for reporting historical investment returns for the various 

investment options, CSPN can only offer links to historical return data for the various 

plans. It would be a great help to investors if a standard reporting format were developed 

and the information was available directly on the CSPN web site. Also, there is little 

information currently available on how Section 529 plan participation varies with income, 

on the distribution of annual contributions and account balances, and on how Section 529 

plans are invested at the account level. Such information would help policymakers. To 

help fill this gap, Treasury worked with the CSPN and the College Savings Foundation to 

devise a survey questionnaire. Treasury will analyze these data when they become 

available and share further findings with relevant policymakers. 

Recommendation 5: Improved Monitoring and Compliance. Section 529 accounts 

are still relatively new. To reduce the potential for abuse, Congress and the states should 

work together to strengthen compliance and monitoring of Section 529 accounts and their 

disbursements. 
23

REFERENCES

Alexander, Raquel Meyer and LeAnn Luna (2009). “How Investors Respond to 

Disclosures: The Case of 529 College Savings Plans,” Working Paper. 

Boshara, Ray, Margaret Clancy, David Newville, and Michael Sherraden (2009). The 

Basics of Progressive 529s, February. 

Dynarski, Susan. (2004). Who Benefits from the Education Saving Incentives? Income, 

Educational Expectations and the Value of the 529 and Coverdell. National Tax 

Journal, 57(2), 359-383. 

Dynarski Susan. (2004). Tax Policy and Education Policy: Collision or Coordination? A 

Case Study of 529 and Coverdell Savings Vehicles. National Bureau of Economic 

Research, Inc, NBER Working Papers: 10357 

Hurley, Joseph F. (2008). The Best Way to Save for College, A Complete Guide to 529 

Plans, Bankrate Inc. 

Internal Revenue Service (2008), Publication 970, Tax Benefits for Education, 

http://www.irs.gov/publications/p970/index.html. 

Joint Committee on Taxation (2008), Present Law and Analysis Relating to Tax Benefits 

for Higher Education, April 29. 

National Center for Education Statistics (2009), Digest of Education Statistics 2008, 

March. 

Standard and Poor’s (2009). Standard and Poor’s Indices Versus Active Funds Scorecard, 

Midyear 2009, 

http://www2.standardandpoors.com/spf/pdf/index/SPIVA_2009_Midyear.pdf. 
State Plan

Other State

 Plans State Plan

Other State

 Plans

Single

Taxpayer

Married

Filing Join

Alabama Yes No* None None NA AlaskaArizona Yes Yes Deduction Deduction 750 Arkansas Yes Yes Deduction None 5,000 1California Yes Yes None None NA Colorado Yes Yes Deduction None No Limit No Connecticut Yes Yes Deduction None 5,000 1Delaware Yes Yes None None NA District of Columbia Yes Yes Deduction None 4,000 FloridaGeorgia Yes Yes Deduction None 2,000 Hawaii Yes Yes None None NA Idaho Yes Yes Deduction None 4,000 Illinois Yes Yes Deduction None 10,000 2Indiana Yes Yes Credit, 20 percent None 1,000 Iowa Yes Yes Deduction None 2,800 Per Ben. 5,600 PeKansas Yes Yes Deduction Deduction 3,000 Kentucky Yes Yes None None NA Louisiana Yes Yes Deduction None 2,400 Per Ben. 4,800 PeMaine Yes Yes Deduction Deduction 250 Per Ben. 250 PeMaryland Yes Yes Deduction None 2,500 Per Ben. 2,500 PeMassachusetts Yes Yes None None NA Michigan Yes Yes Deduction None 5,000 1Minnesota Yes Yes None None NA Mississippi Yes Yes Deduction None 10,000 2Missouri Yes Yes Deduction Deduction 8,000 1Montana Yes Yes Deduction None 3,000 Nebraska Yes Yes Deduction None 5,000 NevadaNew HampshireNew Jersey Yes Yes None None NA 

-----------------------------------------------No Income Tax------------------------------------------------------------------------------------------------------------------------No Income Tax------------------------------------------------------------------------------------------------------------------------No Income Tax------------------------------------------------------------------------------------------------------------------------No Income Tax-------------------------------------------------------------------------

Table 1

State Tax Treatments of Section 529 Savings Plans

State Tax Treatment = Federal Tax 

Treatment of Investment Earnings and 

Distributions for Qualified Education 

Expenses?

State Tax Deduction

or Credit for Contributions 

State 

Deduction or Credit Maximum
State Plan

Other State

 Plans State Plan

Other State

 Plans

Single

Taxpayer

Marrie

Filing Joi

New Mexico Yes Yes Deduction None No Limit NNew York Yes Yes Deduction None 5,000 North Carolina Yes Yes Deduction None 2,500 North Dakota Yes Yes Deduction None 5,000 Ohio Yes Yes Deduction None 2,000 Per Ben. 2,000 POklahoma Yes Yes Deduction None 10,000 Oregon Yes Yes Deduction None 2,000 Pennsylvania Yes Yes Deduction Deduction 12,000 Per Ben. 12,000 PRhode Island Yes Yes Deduction None 500 South Carolina Yes Yes Deduction None No Limit NSouth DakotaTennessee No Savings Plan Yes None None NA TexasUtah Yes Yes Deduction None 1,740 Per Ben. 3,480 PVermont Yes Yes Credit, 10 percent None 250 Per Ben. 500 PVirginia Yes Yes Deduction None 4,000 WashingtonWest Virginia Yes Yes Deduction None No Limit NWisconsin Yes Yes Deduction None 3,000 Per Ben. 6,000 PWyoming

Table 1 (continued)

State Tax Treatments of Section 529 Savings Plans

*Alabama taxes distributed earnings of other state plans. 

State

State Tax Treatment = Federal Tax 

Treatment of Investment Earnings and 

Distributions for Qualified Education 

Expenses?

State Tax Deduction

or Credit for Contributions

-----------------------------------------------No Income Tax-----------------------------------------------------------------------

--------------------------------------------------------------No Income Tax-----------------------------------------------------------

-----------------------------------------------No Income Tax----------------------------------------------------------------------------------------------------------------------No Income Tax-----------------------------------------------------------------------

Deduction or Credit Maximu
26

Low Medium High

State Tax Rates, All Income 6 6 6

Federal Tax Rates

Interest 15 28 35

Qualified Dividends 5 15 15

Qualified Capital Gains 5 15 15

Total Tax Rates*

Interest 20.1 32.3 38.9

Qualified Dividends 10.7 20.1 20.1

Qualified Capital Gains 10.7 20.1 20.1

Income Level

Item

Table 2

Tax Rates For Illustrations of Section 529 Tax Benefits

*Takes account of deduction of state taxes from the federal tax base.
27

Taxed

Acct.

529 wo 

State Ded.

529 w

State Ded.

Penalty

Imposed

529 wo 

State Ded.

529 w

State Ded.

Penalty

Imposed

(1) (2) (3) (4) (5) (6) (7) (8) (9)

Low 1,219 1,289 1,371 1,158 6 13 -5 54

Medium 1,169 1,289 1,371 1,105 10 17 -6 65

High 1,157 1,289 1,371 1,076 11 19 -7 62

Low 1,423 1,568 1,669 1,324 10 17 -7 59

Medium 1,325 1,568 1,669 1,224 18 26 -8 71

High 1,300 1,568 1,669 1,171 21 28 -10 68

Low 1,665 1,908 2,030 1,535 15 22 -8 65

Medium 1,506 1,908 2,030 1,383 27 35 -8 77

High 1,465 1,908 2,030 1,302 30 39 -11 73

--------------------------------------- 10 Year Accumulation Phase -----------------------------------

Income

Level

--------------------------------------- 15 Year Accumulation Phase -----------------------------------

Percent Change from

 "Taxed Acct."

Break-even 

Prob of

Penalty**

(Percent)

*This table compares the amount of real expenditure that can be financed over 4-year periods (taken in 4 equal installments) with 

$1,000 of initial saving for three sets of assumptions for tax rates (income levels), three cases for how long the account is invested 

before expenditures begin (5 years, 10 years, or 15 years), and four cases with respect to how investment earnings are taxed. The 

tax rates associated with each income level (column 1) are given in Table 2. The four cases for how investment earnings are taxed 

are: Column 2 assumes the savings takes place in an ordinary taxed account, column 3 assumes the saving is done in a Section 529 

account with no state tax deduction for contributions, column 4 assumes the saving is done in a Section 529 account for which the 

initial $1,000 contribution is deductible from the state tax base, and column 5 assumes the savings takes place in a Section 529 

account but that withdrawals are not used for qualified education expenses, so that the earnings portion of distributions are taxed at 

the account owner's ordinary tax rate plus 10 percentage points. 

**Relative to a taxed account, a Section 529 account without a state tax deduction conveys a tax benefit equal to the

difference between columns (3) and (2) if it is used for qualified education expenses, and conveys a tax penalty equal to the

difference between columns (5) and (2) if used for other purposes. If the probability of the penalty case (p) is the value 

shown, and the probability of taking qualified distributions is (1-p), then the family on average pays the same taxes on a 

Section 529 account as on a taxed account. If the probability of the penalty case is smaller than the value shown, then the 

family on average receives a net tax benefit from a Section 529 account.

Real Expenditures Financed with $1,000 of 

Initial Saving 

--------------------------------------- 5 Year Accumulation Phase -----------------------------------

Table 3

Tax Benefits of Section 529 Savings Plans*
28

Table 4 

State Section 529 Matching Grant Programs for Low and Middle Income Families* 

State Matching Grant* 

Arkansas • 200% match up to $500 grant/year, family AGI no higher than 

$30,000 

• 100% match up to $500 grant/year, family AGI between $30,000 and 

$60,000 

Colorado • 100% match up to $500 grant/year, family income less than 200% of 

poverty, for maximum of 5 years 

Kansas • 100% match for annual contributions between $101 and $600, 

family income less than 200% of poverty level, maximum of 3 years 

Louisiana • 14% match, family AGI less than $30,000 

• 12% match, family AGI between $30,000 and $44,999 

• 9% match, family AGI between $45,000 and $59,999 

• 6% match, family AGI between $60,000 and $74,999 

• 4% match, family AGI between $75,000 and $99,999 

• 2% match, family AGI $100,000 and above 

Maine • $200 grant when account opened with contribution of $50 or more 

• 50% match up to $200 grant/year, must contribute $50 or more, 

family AGI $75,000 or less 

Michigan • 33-1/3% match up to $200 grant for first year of enrollment, family 

AGI $80,000 or less 

Minnesota • 15% match up to $400 grant per year, family AGI $50,000 or less 

• 10% match up to $400 grant per year, family AGI between $50,000 

and $80,000 

North Dakota • 100% match up to $300 grant in year account opened, family AGI 

below $40,000 (single) or $80,000 (joint). 

• 100% match up to $300 grant per year, family AGI below $40,000 

(single) or $80,000 (joint), maximum of 3 years. 

Rhode Island • 200% match up to $1,000 grant, family’s AGI of $71,000 or less 

• 100% match up to $500 grant, family AGI between $71,000 and 

$86,000 

Utah • 100% match up to $400 grant, family income less than 200% of 

poverty, limited to 500 accounts. 

Source: Boshara et.al (2009), http://www.savingforcollege.com, and web sites for the 

various plans. 

*Grants available to account owners who are either single or married filing jointly, and 

who are parents of the beneficiary. 
29

Accounts Balances

Tax

Returns**

Federal 

Adjusted

Gross 

Income**

0-50 3,393 15.9 4,689 23 10 74 28

50-75 2,193 12.6 5,768 15 8 11 16

75-100 2,530 16.4 6,496 17 10 7 13

100-200 4,490 46.9 10,437 30 30 7 21

>200 2,308 66.3 28,718 15 42 2 22

All 14,914 158.1 10,603 100 100 100 100

>100 6,798 113 16,644 46 72 9 43

Source: Louisiana's START Saving Program and IRS Statistics of Income (http://www.irs.gov/taxstats/article/0,,id=171535,00.html)

*23 percent of account owners with 19 percent of balances did not have verified AGI and are not included in the table. These include accounts 

for which a contribution was not made in 2008, and accounts not providing AGI information and which are granted the minimum match of 2 

percent. 

**Total number of tax returns and federal AGI in each federal AGI category.

Percent of:

Table 5

Louisiana Section 529 Account Balance Distribution by 2007 Federal Adjusted Gross Income*

(Accounts with Verified AGI, August 20, 2009)

Federal 

Adjusted

Gross Income

($1,000's)

Number of

Account

Owners

Total

Balances

$Millions

Average

Balance

Taxpayers

Claiming

Kansas Tax

Deduction Deductions

Kansas

Tax

Returns*

Kansas

Federal 

Adjusted

Gross Income*

0-50 1,632 3.6 2,189 8 4 67 24

50-75 2,392 5.5 2,308 12 6 13 16

75-100 3,382 9.0 2,672 17 9 8 14

100-250 9,205 42.7 4,639 46 44 9 29

>250 3,524 36.4 10,323 18 37 1 17

All 20,135 97.2 4,828 100 100 100 100

>100 12,729 79 3,928 63 81 11 46

Source: Kansas Department of Revenue and IRS Statistics of Income (http://www.irs.gov/taxstats/article/0,,id=171535,00.html)

*Total number of Kansas tax returns and amount of Kansas federal AGI in each federal AGI category.

Percent of:

Table 6

Distribution of 2007 Kansas Section 529 Account Contributions Deducted From State Tax Base 

by 2007 Federal Adjusted Gross Income

Federal 

Adjusted

Gross Income

($1,000's)

Taxpayers

Claiming

Kansas Tax

Deduction

Total

Deductions

$Millions

Average

Deduction
30

0-25 25-50 50-75 75-90 90-95 95-100

With Children

Observations** 1,439 1,479 1,428 966 440 1,808

Percent with 529/Coverdell 0.4 1.2 8.6 15.0 27.8 31.4

(0.4) (0.6) (1.7) (2.6) (4.8) (2.4)

With Children and 529 Account***

Observations** 1 20 112 148 117 352

Average for

529/Coverdell/MSA Balance 3,000 8,794 8,111 15,482 30,674 106,250

NA (14,473) (1,709) (3,979) (7,891) (23,620)

529/Coverdell Balance, Percent of Income 10.8 20.0 10.2 13.4 18.0 24.5

NA (32.9) (2.2) (3.5) (4.8) (7.2)

Number Children 1.0 1.3 1.9 1.8 2.4 2.0

NA (0.2) (0.2) (0.1) (0.2) (0.1)

Age Oldest Child 17.0 13.0 12.7 11.9 12.0 12.8

NA (2.6) (1) (1) (1.1) (0.6)

Income 27,766 47,827 80,005 120,177 176,284 548,077

NA (3,200) (1,834) (2,503) (4,118) (60,994)

Percent of Total: 

529/Coverdel Balance 0.0 1.1 7.0 13.9 18.5 59.4

 Income 0.0 1.0 11.6 18.1 17.9 51.3

Table 7

Section 529 and Coverdell ESA Account Balances By Income Group*

Income Range, Percentiles for Households with Children

Item

*Tabulations are from the 2007 Survey of Consumer Finances. Section 529 accounts are combined with Coverdell and with Medical Savings Accounts 

(MSAs) in the public dataset. However, the Federal Reserve Board has indicated in private corresondance that no survey respondents reported an MSA.

**To allow for uncertainty in imputed values, the SCF replicates each observation 5 times. The true number of observations is the reported number divided 

by 5. Standard errors have been adjusted to reflect the true number of observations. 

***The 529/Coverdell account balance was imputed for 23 percent of the sample reporting having an account, and in 70 percent of those cases the respondent 

gave a account balance range. Only imputations for which an account balance range was given are included in the lower part of the table. 
31

Plans

States with 

Plans Plans

States with 

Plans

Number of Plans/States* 55 48 31 27

Investment Options

Total for all Plans/States 590 590 547 547

Minimum Across Plans/States 1 2 6 6

Maximum Across Plans/States 30 60 30 50

Average Across Plans/States 11 12 18 20

Plans/States with at Least One of 

Option Type:

Age-Based 49 43 25 21

Blended 47 40 28 24

Equity 46 42 27 25

Fixed Income 44 38 24 24

Capital Preservation/Money Market 41 37 24 20

Plans/States with at Least One of 

All Option Types 28 27 12 12

Direct Sold Advisor Sold

Table 8

Number and Type of Section 529 Investment Options

Item

Source: College Savings Plan Network.

*States without direct sold or advisor sold plans are Tennessee, Washington, and Wyoming. 

57 Funds

24 Index

Funds

33 

Managed

Funds 57 Funds

24 Index

Funds

33 

Managed

Funds 57 Funds

24 Index

Funds

33 

Managed

Funds

Minimum 0.24 0.24 0.25 2.2 2.2 2.3 6.9 6.9 7.2

25th Percentile 0.53 0.50 0.75 4.8 4.5 6.7 14.9 14.1 20.9

50th Percentile 0.76 0.55 0.92 6.8 5.0 8.1 21.2 15.5 25.4

75th Percentile 0.95 0.75 1.06 8.4 6.7 9.3 26.2 20.9 29.1

100th Percentile 1.30 1.03 1.30 11.2 9.0 11.2 35.2 28.3 35.2

Average 0.78 0.61 0.90 6.9 5.4 8.0 21.6 17.0 24.9

*Periodic actual fees levied are a percent of account balances. The "expense ratio" shown here is annual fees levied on account holders expressed as a percent of the 

fund's average net asset value over the year. 

*A front-load fee is a percent levy on each account contribution. The calculations of the equivalent front load fee and the percent of returns absorbed by fees 

assume 17 years of monthly contributions sufficient to fund 4 years of college expenses if there are no account fees, real annual college costs growth 2 percent 

annually from a current level of $11,000, and nominal annual returns before fees are 7.0 percent nominal and 4.5 percent real. The time pattern of real contributions 

are assumed to grow 1 percent annually. Annual account maintenance fees are not included in the calculations because they are often waived for various reasons and 

they are generally small and of little consequence for accounts of the size here assumed. 

Table 9

Section 529 Account Fees for Direct Sold Moderate Risk Age-Based Fund 

for Current 5-Year-Old 

Asset-Based Fees Levied*

(Percent at Annual Rate)

Front Load Fee Equivalent to AssetBased Fees Levied** (Percent)Percent of Real Returns Absorbed by 

Fees**

Item
32

Item

Front-Load

Fee Equivalent to All 

Fees Levied

Percent of

Real Returns

Absorbed by Fees

Minimum 12.3 38.5

25th Percentile 14.4 44.9

50th Percentile 15.3 48.0

75th Percentile 16.5 51.5

100th Percentile 17.9 56.1

Average 15.2 47.7

*Assumptions underlying calculations are detailed in footnote to Table 10. Fees 

included in the calculations are annual asset-based fees ranging from 0.93 percent to 

1.61 percent and front-load sales charges that decline with the size of the account 

balance. The maximum sales charges range from 3.5 percent to 5.75 percent. Annual 

account maintenance fees are not included in the calculations because they are often 

waived for various reasons and they are generally small and of little consequence for 

accounts of the size assumed.

Table 10

Section 529 Account Fees for 29 Advisor Sold Moderate Risk Age-Based 

Funds for a Current 5-Year-Old 
33

Plan Plan Type

Payouts Can be Directed to Private

and Out-of-State Schools?

Alabama Contract Yes

Florida Contract Yes

Illinois Contract Yes

Maryland Contract Yes

Massachusetts Voucher Payout to out-of-network schools equal to 

contributions adjusted for general price inflation

Michigan Contract Yes

Mississippi Contract Yes

Nevada Contract Yes

Pennsylvania Unit Yes

Tennessee Unit Yes

Texas Promise Contract Yes

Virginia Contract Payout is lesser payout at a Virginia school and sum 

of contributions and actual earnings

Washington Unit and Contract Yes

Table 11

Prepaid Tuition Plans Currently Open to New Enrollment

Source: Internet web sites of the various plans, links to which are at http://www.collegesavings.org/index.aspx
34

23456

2 4.9 4.5 4.2 3.8 3.5

3 5.6 5.2 4.8 4.5 4.1

4 6.2 5.9 5.5 5.2 4.8

5 6.9 6.5 6.2 5.8 5.5

6 7.5 7.2 6.9 6.5 6.2

Table 12

Annual Rate of Real Tuition Inflation that Makes Ex Post Value 

of a Prepaid Tuition Plan Equal to a Section 529 Savings Plan*

(Average Across Ten Prepaid Plans)

Real

Annual 

Investment

Return

Annual Rate of Price Inflation

Source: Treasury calculations based on prepaid plan contract terms found on the various 

plan web sites. Links to plan web sites are at http://www.collegesavings.org/index.aspx.

*The real annual investment return is the nominal return in excess of general price inflation. 

Similarly, real tuition growth is tuition growth in excess of general price inflation. Shaded 

cells are those with real tuition growth is judged to be within the range of recent historical 

experience--less than or equal to 4.5 percent. The Virginia plan is more generous the more 

expensive the Virginia school attended; the estimates assume an "average" Virginia school 

is attended.

23456

2 40 50 70 80 80

3 0 40 50 50 80

4 0 0 0 50 50

5 00000

6 00000

Source: Treasury calculations based on prepaid plan contract terms found on the various 

plan internet web sites. Links to plan web sites are at 

http://www.collegesavings.org/index.aspx.

Table 13

Percent of Ten Prepaid Plans That Outperform a Section 529 Savings 

Plan if Annual Real Tuition Growth is 4.5 Percent

Real

Annual 

Investment

Return

Annual Rate of Price Inflation
Figure 1

Section 529 Assets

0

4080

120

2001:Q4 2002:Q4 2003:Q4 2004:Q4 2005:Q4 2006:Q4 2007:Q

Quarter

$Billions

Savings Plans

Prepaid Plans

2001Q4

2007Q4

2008Q4

2001:Q4-2007:Q4

2007Q4-2008:Q4

Total 14 130 105 857 -19.2Savings 11 115 92 934 -19.5Prepaid 2 15 13 513 -17.5

Asset Levels ($Billions)

Average Annual

Growth (Percent)

Asset Type
Figure 2

Real Tuition Costs at 4-Year Public Universities 

$0

$2,000$4,000$6,000

1976–77 1978–79 1980–81 1982–83 1984–85 1986–87 1988–89 1990–91 1992–93 1994–95 1996–97 1998–99 2000–01 2002–03 20

Year

Average Annual Growth Rates

 1980/81 - 1999/00 4.1% 1999/00 - 2007/08 4.5%

Source: National Center for Education Statistics (2009).
Figure 3

Real Tuition Costs at 4-Year Public Universities-- 

Average Annual Growth Rate for 10 Years Ending in Year Shown 

1.52.02.53.03.54.04.55.0

1986–87 1988–89 1990–91 1992–93 1994–95 1996–97 1998–99 2000–01 2002–03 200

Year

Source: National Center for Education Statistics (2009).