Recent policy debates about overhauling the federal tax code have propelled 529 education savings plans into the spotlight. These plans allow post-tax contributions to grow and be withdrawn tax free as long as the proceeds are used to pay for qualified education expenses. The Tax Cuts and Jobs Act, enacted in late 2017, expanded the use of these accounts by allowing them to cover certain K-12 expenses. Now proposals are being floated for a second round of federal tax changes that could allow 529 plans to be used to pay for home schooling and apprenticeships, and to pay down student loans.
These kinds of changes have the potential to affect federal and state revenue because of the way the tax codes and laws related to 529 plans intersect. As policymakers consider the implications of changes both enacted and proposed, they should be aware that the costs—meaning the forgone revenue—of 529 plans were already rising. This spending through the tax code has historically been a small part of the total federal support for higher education, but the costs related to 529 plans have grown in recent years along with participation.
Research by The Pew Charitable Trusts finds that some states also have experienced cost increases related to 529 plans, although information on this forgone revenue is limited. Analyzing what is known about 529 plan costs and how they have changed can help policymakers understand the potential impact of the changes made by the tax bill, and others yet to be enacted.
529 plans are savings accounts intended to help Americans save for the education of a beneficiary such as a child or grandchild. They are typically administered by states and provide tax benefits at both the state and federal levels.
Post-tax contributions can grow and be withdrawn tax free as long as the proceeds are used to pay for qualified expenses. Before enactment of the 2017 federal tax law, those expenses included tuition, fees, books, room and board (if a student enrolls at least half time), and technology and equipment expenses at institutions of higher education. The new law expanded the definition of qualified expenses to include tuition at K-12 private schools but limited withdrawals for this purpose to $10,000 a year per child; there are no limits on withdrawals for approved college expenses.
To date, the forgone federal revenue from 529 plans has been modest compared with other forms of federal support for higher education. In 2017, the costs totaled $2 billion, about 6 percent of all federal tax expenditures on higher education. But these costs have grown, rising by about $389 million—nearly 25 percent—since 2010, after adjusting for inflation. The Treasury Department projects that by 2027, the total will more than double to $4.1 billion in nominal terms and rise to 10 percent of higher education tax benefits. The department made those estimates before Congress expanded 529s to allow for certain K-12 expenses; the projection reflects the law as of July 2017.
This pattern of rising costs mirrors growing use of 529 plans. Nationally, total assets held in state-sponsored plans grew from an inflation-adjusted $176.2 billion in 2010 to $318.7 billion in 2017, an increase of 81 percent. The analysis includes information from the College Savings Plans Network and includes only data from state-sponsored 529 plans. It does not include 529 plans operated by private firms. Assets in 529 plans increased in all but three states; 38 plus the District of Columbia recorded increases of greater than 50 percent.
This growth reflects two key trends:
Increased use of 529 accounts may also have an impact on state-level tax benefits related to the plans. Previous research by Pew found that all 41 states and DC that levied a personal income tax in 2014 followed the federal government in allowing 529 plan earnings to grow tax free as long as the money is used for qualified higher educational expenses. These states typically begin their tax calculations with a federal definition of income—the adjusted gross income or taxable income—that excludes these earnings. In addition, 33 states and the District provided income tax deductions or credits for 529 contributions as of 2014. There are no additional tax deductions for contributions to 529 plans at the federal level.
Information on the state costs of 529 tax benefits—tax deductions or credits for contributions as well as the tax exemption granted on investment returns—is limited. In prior research, Pew was able to obtain at least partial cost estimates for only about half the states that provided these tax benefits in 2014. Still, in at least some states where cost information is available, the lost revenue appears to mirror patterns at the federal level. For example:
To ensure that policymakers are deploying resources effectively, those considering the implications of recently enacted and proposed 529 expansions should pay close attention to the overall costs and how they fit within their states’ broader systems of education investments. Forgone revenue from 529 plans is a moving target because of uncertainty about participation and investment returns, among other factors, which means lawmakers need to comprehensively track these costs over time. Increased awareness of and participation in these plans could mean greater forgone revenue in coming years.
States also need to close the information gap on publicly available estimates of the forgone revenue associated with 529 plans. These actions could help policymakers better understand the overall costs and the relationships between the state and federal programs that support education. With solid data, they will be better prepared to assess the best use of education dollars to achieve key policy goals.
Phil Oliff is a senior manager, Laura Pontari is an associate, and Rebecca Thiess is an associate manager with The Pew Charitable Trusts’ fiscal federalism initiative.