Why 529 Plans are Great for the Wealthy

Last Updated Mar 10, 2011 5:41 PM EST

Are wealthy families the biggest beneficiaries of 529 plans?

The Education Sector just released a paper that illustrates why the wealthiest Americans are enjoying out-sized benefits from state 529 plans.

In an effort to make their 529 savings plans attractive, the majority states - 34 out of the 43 state with income taxes -- long ago added an amazing perk to the accounts. Residents in these states, who contribute to own their state's 529 plan, get to pocket income tax deductions which can be quite hefty.

What's more, 529 withdrawals to pay for college expenses are exempt from federal income taxes. The federal income tax subsidy, according to the Education Sector, costs the federal government $600 million a year.

So what does this have to do with wealthy parents? Obviously, a family of millionaires is going to be able to sink more money into 529 accounts than others. But I was surprised at how lopsided the benefits are.

In its paper, the Education Sector examined what families derived the most value from the tax benefit in the state of Kansas. Here's what they found:

Although 80% of Kansas taxpayers earned less than $75,000 in 2007, they collected only 10% of the 529 tax deductions. In contrast only 1% of Kansans earned more than $250,000, yet they claimed 37% of the total tax benefits for 529 plans.
The average deduction for wealthy Kansans was nearly five times larger than the ones claimed by Kansas residents earning less than $50,000.
Public data from other states, the Education Sector noted, confirmed that 529 tax benefits tend to be concentrated among the wealthy.

During this time of financial crisis in Washington DC and state capitols across the country, can we really afford these tax break goodies for the wealthiest parents? I don't think so.

Of course, if you're wealthy, you'd be crazy not to take advantage of this sweet deal. What other type of investment account lets you capture a tax break on the front end and avoid taxes on the back end too? I can't think of any. Even the Roth IRA isn't that sweet of a deal.

Lynn O'Shaughnessy is author of The College Solution and she also writes a college blog for CBSMoneyWatch.
529 plan image by Claudio.Ar. CC 2.0.