Jan. 2, 2013 -- A federal plan meant to help families save for college tuition is overwhelmingly benefiting wealthy families, a federal review has found.
The financial instruments, known as 529 college savings plans, contribute to a billion dollar industry but are utilized by less than 3 percent of families with college students, according to a study released last month by the Government Accountability Office.
And those families, the GAO found, were almost exclusively wealthy. Families that did have a 529 plan or a similar investment vehicle for college savings had 25 times the median financial assets of families that did not and three times the median income, the GAO said.
Although 529s were created to help families of all income levels be able to afford college, Laura Lutton, director of 529 plan research for investment firm Morningstar, said, "This research suggests that's not the primary use of the plans."
The plans, named after Section 529 of the Internal Revenue Code in 1996, allows parents or grandparents to set up a savings plan for a child right at birth. In 2001, the federal government allowed distributions from 529 accounts to be entirely tax-exempt if used to pay for college tuition and fees, which have been increasing at a rate of 6 percent.
Lutton said it will be interesting to see how lawmakers in Washington respond to the report.
The foregone federal revenue from college savings plans is about $1.6 billion, according to the Treasury Department in the fiscal year of 2011.
"The fact that wealthier families are taking advantage of these in larger numbers shows it's not a vehicle that is as widely used as many would think as a goal in the industry," Lutton said.
Lutton said she was not entirely surprised by the GAO's report, as she had heard anecdotally about the average account size and customers. She also said previous research showed that about 51 percent of 529 plans are sold directly to individuals while 49 percent are sold through a financial adviser.
"If you are working with a financial adviser, there are some financial means there. If that's half the assets in the industry, I think one could logically conclude that is why you see so many wealthy families utilizing the investments," Lutton said.
The report points out that higher income households tend to benefit more from the tax-free earnings from a 529 plan because of their higher tax rate.
The GAO report said that some of the primary reasons preventing families from participating is their ability to save, awareness of 529 plans as a savings option and difficulty in choosing a plan.
"Parents have a lot of expenses before you even get to save for college," Lutton said.
She said, "The states are very intent on educating their residents about what their plan is," but there is still the obstacle of a bewildering number of 529 plans to choose from. There are over 100 of them managed by states. And while you do not have to choose a 529 savings plan offered in your state of residence, many states offer tax breaks if you do.
"You can buy the one from your state, or maybe you shouldn't," Lutton said.
In addition, some families are concerned that saving greater amounts of money for college may impact potential financial aid for their child.