Education Savings Accounts: Giving Families Ownership in
June 22, 2006
With college tuitions soaring, parents are
beginning to save for their children's education earlier and
earlier. A growing number of families are putting their savings in
education savings accounts (ESA), which enjoy certain tax
advantages. The popularity of these accounts suggests that parents
want to control the resources spent on their children's education.
Policymakers should consider how these accounts could be used to
expand school choice and improve American education.
Federal law provides two kinds of educations
savings accounts. So-called 529 plans allow for tax-protected
savings for higher education through state-managed plans. Coverdell
ESAs allow for tax-free savings in privately-managed accounts for
K-12 and higher education expenses.
529 accounts-named after a section in the IRS
code-offer families two ways to save for college expenses. This
first option is to lock in today's tuition rates and prepay tuition
at a participating higher education institution. The second is to
invest in a state-managed investment account where earnings grow
tax-free and can be used for tuition when a child enrolls.
Under 529 plans, annual contributions can
range from $10,000 up to $300,000 in some states. States contract
with financial institutions to manage the 529 accounts, and each
state offers families different investment options. Most states
don't require residency to invest in a 529 plan, and so families
are free to shop the state plans to find the best investment. This
is important, because some states offer different fees and rates of
returns, and competition ensures that families can get the best
The Financial Research Corporation reports
that total assets in 529 college savings plans totaled $68 billion
at the end of 2005-30 percent over 2004 levels. One reason for the
growing use of 529 plans is that 25 states provide various tax
incentives-credits or deductions-for investment contributions.
(Learn more about 529 accounts here and whether your state offers tax incentives
Until now, states have limited tax incentives
for contributions to the state's own plan. But this year, the Maine
state legislature enacted a per-beneficiary deduction worth $250
per year for a contribution to any state's 529 plan. This
could pave the way for more states to provide tax breaks for
out-of-state plans. If so, families can look forward to greater
competition among providers and better investment options and
Unlike 529 plans, Coverdell Education Savings
Accounts (ESAs)-named after the late Georgia Senator-let families
contribute up to $2,000 per child annually in a tax-free savings
account that can be used for K-12 or higher education expenses.
Eligible expenses include K-12 private school tuition, books,
school supplies, tutoring, and after-school programs. Unlike 529
college savings plans, Coverdell ESAs can be opened and managed by
banks and brokerage firms, similar to 401(k) accounts.
No state currently offers tax incentives for
Coverdell ESAs. And since the tax benefits of Coverdell ESAs are
deferred, few families are using them. But many American families
could make good use of this opportunity to save for their
As familiarity with education savings accounts
grows, supporters of parental choice in education should consider
reforms that give families control of education resources.
One option would be for states to level the
playing field between 529 accounts and Coverdell ESAs by evening
out the tax breaks for contributions to either savings vehicle.
Another option would be for Congress to reform 529 accounts to
include K-12 education expenses, like Coverdell ESAs do today. At a
minimum, federal lawmakers could increase contribution limits for
Coverdell ESAs to give families greater ability to save.
The promise of a system of widespread ESAs is
great. Parents, grandparents, and other relatives would have
greater opportunities to save for a child's education. Charities,
corporations, and individuals could be given incentives to make
contributions to low-income children's accounts, which could be
used to pay school or college tuition or any other legitimate
educational expense. State governments could create matching-funds
plans to help needy children-seven states are already doing this
with their 529 plans.
Widespread use of education savings accounts
would improve the efficiency of education spending. According to
the Department of Education, U.S. taxpayers spend approximately
$500 billion annually on K-12 education. Government officials and
bureaucrat largely dictate how it's spent. Expanding access to
education savings accounts would begin to return control of
education decisions to parents. With parents in charge, educators
would compete for students and tailor their products and services
to individual children's needs.
competition are keys to improving American education. By giving
parents greater power to direct their children's education,
education savings accounts could make widespread choice and
competition a reality.
Dan Lips is
Education Analyst at the Heritage Foundation, www.Heritage.org.