September 2001


New York, NY - 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.

** 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.

© 2014 and prior years, Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), New York, NY 10017