Abstract: Coverdell education savings accounts (ESAs), created through
the federal tax code, allow families to save money tax-free for K–12 and higher
education expenses. Lifting the cap on contributions to Coverdell accounts would
provide greater access to school choice options by allowing families to invest
more money in their children’s education. Additionally, existing “529” college
savings accounts should be expanded to allow families to save for K–12 education
expenses. Both reforms would allow parents to use more of their money for a
child’s private-school tuition or other education expenses. Since most states
offer either tax credits or deductions to encourage saving in a 529 plan,
expanding it to make K–12 expenses allowable would effectively create
opportunities for millions of American families to open ESAs.
The momentum for school choice in the United States has never been greater. In
2011, more states passed school choice legislation than in any previous year.
Today, 18 states and Washington, D.C., have some form of private-school choice.
Some states provide school choice through scholarships, also known as vouchers,
which go directly to students to be used at a private school of the family’s
choice. Other states provide tax credits to individuals or corporations that
contribute money toward children’s scholarships. Some states provide both types
of programs. Education savings accounts (ESAs)—currently available only in
Arizona—are a particularly innovative approach to school choice, allowing
families of special needs children to use a portion of the dollars that would
have been spent on their children in their assigned public schools for a variety
of other education options, including private-school tuition, online education,
and special-education services.
States and localities have, appropriately, led the way on school choice, since
nearly all education funding and constitutional authority for education rests
with them. The federal government can also advance school choice by relieving
Americans’ tax burden, particularly when they save for education.
Today, Coverdell accounts, created through the federal tax code, allow families
to save money tax-free for K–12 and higher education expenses. Lifting the cap on contributions to Coverdell
accounts would provide greater access to school choice options by allowing
families to invest more money in their children’s education. Additionally,
existing “529” college savings accounts—named after section 529 of the Internal
Revenue Code that established the accounts in 1996 in federal law—should be
expanded to allow families to save for K–12 education expenses. Both reforms to
the federal tax code would empower families to keep more of their own money to
put toward a child’s private-school tuition or other education-related expenses.
Federal policymakers should also promote saving by implementing the policies
proposed in The Heritage Foundation’s Saving the American Dream plan to
“fix the debt, cut spending, and restore prosperity.” Saving the American Dream promotes saving by
treating savings neutrally, eliminating multiple levels of taxation, and taxing
savings only when spent. Reforming and expanding the Coverdell and 529 savings
accounts would be a stepping stone toward how all savings would be treated under
Saving the American Dream. Under the plan, 529 accounts at the federal
level would be superseded by the general savings account proposed in Saving
the American Dream. Meanwhile, states could still offer their own types of
529 accounts, just as they do today.
Since most states offer either tax credits or deductions to encourage saving in
a 529 plan, revising Section 529 of the Internal Revenue Code to make K–12
expenses allowable would effectively create opportunities for millions of
American families to open ESAs. Such an outcome would encourage educational
choice, consistent with long-term goals for reforming the federal tax code.
Lifting the Cap on Coverdell Accounts
Coverdell accounts allow parents to save up to $2,000 per year for a child’s
educational expenses. While
contributions to Coverdell accounts are made with after-tax dollars, interest
earned on contributions accrues free from federal income taxes. Coverdell
accounts are unique in that they allow funding to cover K–12 education expenses
as well as college expenses. Savings can be used for private-school tuition, as
well as for tutoring, special-education services, or other associated education
costs (school uniforms, transportation, books and supplies, etc.). By allowing families to save for
education needs, Coverdell accounts increase educational options for elementary
and secondary students.
Titled after the late Senator Paul Coverdell (R–GA), Coverdell accounts were
signed into law in 2001 as part of President George W. Bush’s Economic Growth
and Tax Relief Reconciliation Act.
Parents may contribute to Coverdell accounts beginning with the birth of their
children, and accounts require that all contributions be made before a child is
18 years of age. Savings must be used by
the time a child is 30 years old—or be distributed to another family member
younger than age 30—to avoid penalty.
(In the case of special-needs students, these age limits do not apply.) Savings
used for purposes other than education are taxable and receive a 10 percent
penalty. There is an income phase-out
range of $220,000 for a married couple ($110,000 for a single filer), meaning
that the allowable annual contribution is reduced if income exceeds that amount.
Corporations and non-profit organizations can make contributions regardless of
While Coverdell accounts increase a family’s options for a child’s K–12
education, they are currently limited by a maximum annual contribution of
$2,000. Lifting the cap on Coverdell accounts would give families greater
financial support and increase school choice options to better direct their
In addition to lifting the cap on Coverdell contributions, policymakers should
ensure that measures are in place concerning potential tax penalties if money
earned in a Coverdell account is not used for education-related expenses. If a
child does not attend a private school, or for whatever reason cannot use the
money accrued in the account, contributors should be allowed to either hand that
money down to the next generation without a tax penalty, or to roll it into
their gross income without an additional tax penalty.
Expanding 529 Accounts to Include K–12 Expenses
States and school districts across the country have appropriately led the way in
expanding school choice options for families. In addition to lifting the cap on
Coverdell accounts, federal policymakers have the opportunity to advance school
choice by making K–12 education costs an allowable expense under 529 college
The federal government currently provides tax advantages for families saving for
college tuition and other higher education expenses. This incentive, known as a
529 college savings account, allows money to grow tax-free, without incurring
federal tax penalties; 529 college savings plans are municipal securities
regulated by states, with contributions largely managed by private investment
firms. In addition to interest accruing free from federal tax penalties, many
states also allow college savings to accrue in 529 accounts without requiring
investors to pay state taxes on interest earned in order to encourage saving. In
these states, families can withdraw money tax-free to pay for tuition, books,
and other education-related expenses at any college, graduate, or trade school.
While 529 plans are codified in federal law, states “retain discretion over
designing plan features, such as investment options, fee structures, and
distribution methods, as well as the state income tax treatment of contributions
and distributions.” Most 529 plans
put contributors’ money into various investments, including stocks and bonds,
with money typically shifting to less risky investments as a child nears college
age. Not only are parents not penalized on the interest earned on money that
accrues in a 529, they can then withdraw that money tax-free, as long as it is
being used to pay for higher education-related expenses. The ability to withdraw money tax-free from a
529 savings account provides a significant advantage over traditional savings
accounts, as interest earned in a traditional savings account is subject to
There are two types of 529 plans: 529 college savings accounts, and 529 prepaid
State 529 Plans. State 529 plans include both prepaid tuition and college
savings plans. All 50 states and Washington, D.C., now offer either the prepaid
or college savings state 529 plan, with 17 states offering both. Washington State offers the prepaid
tuition option but not the college savings plan, while 32 states and Washington,
D.C., offer the college savings option but not the prepaid tuition account. Several states’ prepaid tuition
plans are currently closed to new investors.
Families in Kentucky, for example, have access to the state’s 529 college
savings plan. Through the Kentucky Educational Savings Plan Trust (KESPT),
parents can save money for their child’s future college expenses without having
to pay state taxes on contributions to the account or federal or state taxes on
any earnings that accrue from the investments. In order to remain free from
federal or state tax liability, earnings accrued through the 529 college savings
plan must be used for higher-education expenses.
Anyone can open a 529 account on behalf of a beneficiary, and plans are managed
through the TIAA–CREF financial services company. Kentucky’s 529 college savings plan is overseen by
the Kentucky Higher Education Assistance Authority.
Massachusetts families have access to the U.Plan Prepaid Tuition Program. The
Massachusetts Educational Financing Authority manages the state’s 529 prepaid
college tuition plan, which allows parents to prepay up to 100 percent of their
child’s future college costs at current rates. Parents can prepay tuition at
current rates even though their child might not attend college for many more
The Small Business Job Protection Act of 1996 codified 529 college savings plans
and prepaid tuition accounts through section 529 of the Internal Revenue Code.
Before providing the federal tax incentive, just a handful of states—Florida and
Michigan being the first in 1980—had implemented 529 college savings accounts or
prepaid tuition plans. A subsequent
change to federal law through the Economic Growth and Tax Relief Reconciliation
Act of 2001 amended Internal Revenue Code section 529 to allow distributions,
that is, qualified higher-education expenses, to also be withdrawn tax-free. The
change, which now meant that withdrawals from 529 plans would be exempt from
federal income tax, led to an explosion in interest in state 529 plans.
In fact, 529 accounts have become so popular among families that investments
have increased significantly in recent years. In 2000, there were $2.6 billion
in total investments in 529 plans; by 2006, that figure had increased to $92
billion, and by 2011 had reached $135
billion—a 47 percent increase.
Revising 529 College ESAs to Include K–12 Education Expenses.
Families might question why the federal government tax-advantages one form of
education savings (higher education) over another (K–12). The popularity of 529
college savings accounts indicates that families would likely take advantage of
the option if it were made available for K–12 education expenses.
The biggest advantage to investing in a 529 plan is that withdrawals from the
accounts are free from any federal income tax. Funds spent from 529s are
tax-free, as long as disbursements are used to cover qualified educational
expenses. But there is another significant advantage to 529 plans: In order to
encourage saving for college, 35 states currently provide tax credits or
deductions for contributions to 529s (although contributions cannot be deducted
from federal income tax liability). Of the 44 states that levy an income tax on
earnings, 35 offer credits or deductions for contributions to 529 plans (80
Expanding section 529 of the Internal Revenue Code to allow families to
contribute money to 529 plans for K–12 educational expenses would provide new
incentives for families to save for K–12 education-related expenses while
increasing their ability to pay for education options outside the public-school
This relatively small change to federal tax law could have major implications
for school choice. Since most states have either tax credits or deductions to
encourage saving in a 529 college plan, revising section 529 to include K–12
expenses would likely encourage states to allow parents to deduct their
contributions to 529 plans from their state income tax obligations, in order to
encourage saving for K–12 education costs.
A change in the federal tax code to expand 529 college savings accounts to
include K–12 education expenses could effectively provide access to education
savings accounts for millions of American families. Such an outcome would
significantly expand educational choice, consistent with long-term goals for
reforming the federal tax code.
Recommendations for Federal Policymakers
- Lift the Cap on Coverdell Accounts. Congress can reform the existing
Coverdell program to empower families with increased access to school choice.
The existing $2,000 annual cap on Coverdell contributions prevents the accounts
from being as beneficial as they could be to help families afford a variety of
education options outside the traditional public-school realm. Lifting the cap
on Coverdell contributions would provide greater support for school choice.
- Expand 529 Accounts to Include K-12 Education Expenses. Section 529 of
the Internal Revenue Code should be expanded to allow families to contribute
money to 529 plans for K-12 educational expenses. Contributors should be allowed
to invest in 529 plans, with disbursements for education expenses remaining
exempt from federal income tax requirements. Revising Section 529 to make K–12
expenses allowable would significantly increase the school choice landscape by
creating opportunities for millions of American families to open ESAs.
The momentum for school choice has never been stronger. There is growing
consensus that a child’s educational destiny should not be bound to his or her
parents’ zip code, and that the best way to free children to pursue a bright
future is through educational choice. Existing provisions in federal tax law
could be strengthened and expanded to ensure that parents have the greatest
opportunity to direct their own money to provide a quality education for their
children. Lifting the cap on Coverdell accounts and expanding 529 plans to allow
K–12 expenditures would go a long way toward achieving that goal.
—Lindsey M. Burke is the Will Skillman Fellow in Education, and
Rachel Sheffield is a research associate in Domestic Policy Studies, at The