(NEW YORK, NEW YORK, October 2, 2001) -- According to a recent TIAA-CREF Institute
study titled "Miracle Growth?,"* Section 529 plans have a leg up on
other investment vehicles when it comes to saving for college.
"Saving for college is a very important and challenging task for many
American families," said Douglas Fore, Ph.D., a manager of pension and
economic research at the TIAA-CREF Institute. "With the cost of a four-year
college education estimated to range from $106,000 at public universities to
more than $280,000 at private ones by 2019, we wanted to examine the various
savings vehicles currently available in the market, and determine which ones
will best help people reach their goals."
The study, which appeared in the September issue of Investment Advisor, compares
the potential after-tax accumulations for 529 plans, mutual funds, Education
IRAs, and Series I savings bonds. Assumptions used in the analysis compare the
managed allocation investment option common to most 529 plans against similar
asset allocation strategies used in mutual funds and education IRAs over a six,
12-, and 18-year time horizon. Other assumptions include the effects of individual
tax brackets, state tax deductions, and investment fees.**
Here are some highlights:
529s vs. Mutual Funds
Assuming identical annual contributions deposited at the start of each year,
the advantage of saving with a 529 plan instead of a similar mutual fund during
a six-year time horizon varies between 4.9% and 10.2%, depending on the family’s
tax bracket. Twelve years away from college, the advantage ranges from 9.5%
to 20.9%. With a full 18 years to save for college, the advantage extends from
a low of 14.7% to a high of 34.2%.
Additionally, the study also examined the value of state tax deductions, if
any, associated with 529 plans, and found that the relative advantage of the
529 plan over a comparable mutual fund is significant. For families with 18
years until college, the advantage of the 529 plan with a $5,000 state tax deduction
can be as much as 43%. Even at the six-year time horizon, the advantage ranges
from 13.5% to 17.8%.
529s vs. Education IRAs
While 529 plans do not necessarily outperform Education IRAs in all cases,
their advantages are evident if there is a state tax deduction, or if expenses
for the Education IRA are higher than the 529 plan. Depending on the value of
the state tax deduction, families with 18 years until college saw an advantage
as high as 13.6% in 529 plans. Even at the six-year time horizon, the advantage
is as high as 8.9%.
529s vs. Series I Savings Bonds
The study shows that Series I savings bonds significantly underperform 529
plans when households are not able to receive the tax exclusion on interest
from the bonds (from 6.8% to 26.7%). And the relative advantage of the 529 plan
ranges from 14% to 35% when the value of a state income tax deduction is taken
into account. Only when the time horizon is short, and when households are able
to take advantage of the tax exclusion on interest, do Series I savings bonds
modestly outperform the Section 529 plan, by an average of less than 1%.
Effects of the New Tax Law on 529s
Lastly, the study looked at the ability (beginning in 2002) to have earnings
on distributions from 529 plans used to pay qualified expenses exempt from federal
income tax as a result of the new federal tax law passed in June. How big a
deal is this? Consider this example: The parents of a new baby girl contribute
$5,000 each year in a 529 plan over the next 18 years and it earns 8% annually.
Under the old tax law, they would have $185,397 after paying 15% federal income
tax on earnings. However, under the new tax law, starting in 2002 they would
have approximately $202,000 for college - a $17,000 increase.
"Of course, there are other factors families should examine when choosing
the right college savings vehicle," continued Fore. "They should take
into account their own financial situations and savings goals, and evaluate
the advantages and disadvantages of each investment vehicle to find the best
way to meet their own college savings needs."
The TIAA-CREF Institute, part of the TIAA-CREF group of companies, was established
to foster research and education to support the lifelong financial security
of individuals and their families.
* A copy of the "Miracle
Growth?" study can be viewed on this site.
** This study contains various assumptions and does not reflect the actual
performance, or predict future results of any 529 plan, or any program series,
mutual funds, Education IRAs, or Series I savings bonds.
