There is no greater tool than education for boosting opportunity and combating poverty. Figuring out how to pay for higher education, especially as the costs rise and state supports drop, is a critical challenge.
Investing for future education expenses is a priority for many Texas families. With numerous investment vehicles, it’s important to begin understanding what is available so that families may determine the best method of saving for their unique situations. 529 plans and Children’s Savings Accounts (CSAs) are frequently referenced methods of saving for education expenses, and a discussion of their benefits and drawbacks can be a fruitful starting point for a longer exploration.
What are 529 plans?
Tax-preferred college savings accounts, frequently called 529 plans in reference to the Internal Revenue Service (IRS) tax code that established them, are financial instruments used to save for future post-secondary education expenses.
In general, there are two types of 529 plans:
Prepaid Plans: Prepaid 529 plans allow families to prepay for tuition and fees at colleges. The Texas version of this type of plan, known as the Texas Tuition Promise Fund, allows families to purchase tuition units which apply to future undergraduate resident tuition and fees. The Texas Tuition Promise Fund, has annual enrollment periods between September and February and lets families choose from three types of credits that have different upfront costs and apply to different types of colleges at the time of use. Because Texas law requires all public Texas colleges to accept the prepaid plan, families are essentially able to purchase future education at today’s cost, which is beneficial if one assumes continuing tuition increases. The Texas Prepaid 529 plan does not cover expenses outside of tuition, such as room and board, books, or transportation.
Savings Plans: The second type of 529 accounts, simply described as a savings plan, allows for deposits (of money that has already been taxed) into savings accounts where the money is invested in funds that have the potential to earn returns on investment that are used in combination with contributions to fund education expenses. With this type of 529 savings plan, families take out money from the account, referred to as a distribution, to pay for qualified education expenses which include tuition, fees, books, supplies and special needs services. The income tax benefits of savings plans apply to the recipients of 529 distributions because the distributions are essentially tax-free, unless a family withdraws more from an account that is needed to pay for education expenses. If a family withdraws more than is needed for qualified education expenses, a certain portion of the withdrawal is taxed and a 10 percent penalty tax may apply. While this type of 529 plan is more flexible in the types of expenses the money can apply to, and may have some benefits in expected family contribution calculations, accurately estimating how much to withdraw and determining tax benefits as well as how these savings will interact with other tax items, for example the American Opportunity Tax Credit (AOTC), is not a simple process and would be very difficult for families without extensive knowledge or access to a professional advisor. The Texas College Savings Plan is a version of a college savings 529 plan that touts benefits such as flexible beneficiary designation and no income or age restrictions, but it has been reviewed to have especially high fees that are not offset by significant benefits.
Families may also choose to invest in 529 plans from individual advisors and can also opt to use 529 plans managed by other states given that the chosen plans don’t have residency restrictions.
College Affordability for All
Use of 529 plans has increased in the last few decades, and while many look at 529 plans as vehicles for improving college affordability, these instruments tend to benefit upper and middle-income families more than others. Children’s Savings Accounts (CSAs) are similar savings tools for college, but they tend to focus on college savings for lower-income families. CSA programs are unique in that they can feature savings incentives, financial education, and are thought by some to establish or affirm college-bound identities. Positive outcomes with a prominent CSA program, Promise Indiana, which includes a seed deposit, savings matches, and college and career readiness help, include positive associations between participation and higher math and reading scores. But, a similar 2011 Wheeler-Brooks study found that parents of low or moderate income had trouble finding money to deposit and some felt overwhelmed by the amount of information received in the program.
To ensure all Texans have access to viable college savings solutions, Texas could establish seed-funded CSAs targeted at low-income families. Though numerous institutional barriers contribute to inequity in college affordability, creating statewide programs that incentivize all families to save for future education could be a step in a positive direction.