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How 529 Plans Encourage Higher Education Among Underserved Groups

A closer look at some recent initiatives.

529 college savings plans are state-sponsored programs that families can use to save and invest for education. Unlike using a traditional brokerage account, families who invest in a 529 savings plan can grow their money over time without incurring capital gains taxes, as long as withdrawals are used for qualified education expenses. Although designed for all education savers, these plans are often used by well-resourced households, who learn about the benefits through general financial planning. 

To reach a broader range of families, a number of states have implemented programs that seek to address the issue of accessibility, encourage participation, and target underserved populations. But when our analysts assign ratings to individual 529 plans, Morningstar methodology doesn’t take into account these investor incentives as part of the ratings process: Not every investor can take advantage of them, and some investors shouldn’t. Still, these programs are worth watching, as they may reach families with fewer resources and encourage more children to pursue higher education.

A recent initiative among a number of states is the creation of "child savings accounts." These accounts, of amounts ranging from $50 to $500, are given to children born to (or adopted by) state residents to seed a 529 savings account, often automatically. While these gift accounts may not be large, research from Washington University in St. Louis’ Center for Social Development and University of Michigan’s School of Social Work have found that these types of accounts help raise parental educational expectations and cultivate a college-bound identity in their children.

Maine has the longest-running statewide child savings program. It is not funded by taxpayers and instead is supported by a local foundation. This program is distinctive in that families do not need to sign up. Since 2013, every baby born or adopted in Maine has received a $500 gift under the Alfond Grant program. While the families do not have discretion over the grant account during the investing period, they do receive quarterly statements showing the current value of the $500 grant. These updates also include information stressing the importance of starting early to save for education, including how to open an account in Maine’s college savings plan, NextGen 529. After this initial award, the Finance Authority of Maine, the state administrator of the college savings plan, provides a number of matching grants to encourage families to open their own 529 savings accounts and regularly contribute. Notably, for Maine’s direct-sold plan, the average age of a child at account opening is 5.4 years, below the industry average of 6.6, thanks in part to these incentive programs. Consistent, early contributions can make a big difference in the ending balance; this is supported by Morningstar's research on the subject.

Creating a statewide CSA program takes a lot of political might, as well as funding, so other plans have crafted smaller-scale options. About eight years ago, Utah’s my529 created a platform that allows foundations and nonprofit community organizations to create CSAs that can invest directly in the my529 plan. My529 works with about 30 organizations across the country that focus on low- and moderate-income families, many of which employ a more holistic approach by incorporating mentoring and financial literacy programming at the schools, as well as education milestone incentives, to encourage families to open and invest in 529 savings account. California's ScholarShare 529 also has a similarly designed platform and is currently working with a number of in-state organizations.

Another approach comes from Virginia, which has a program that rewards academic achievement with 529 savings account deposits. SOAR Virginia is an early commitment scholarship program for resident high school students who meet certain family income thresholds. This decade-old program is sponsored by Virginia529, the state’s college savings administrator. Students who qualify and are selected for the program commit to a number of goals, including maintaining a minimum GPA of 2.5, completing a financial literacy course, participating in community service, and regularly meeting with an advisor. Students who meet these requirements are awarded $500 in 10th and 11th grade and $1,000 in 12th grade. These awards are held in Virginia’s Invest529 Stable Value portfolio, and assets are disbursed on the students' behalf to their post-secondary schools.

While these child savings accounts and incentive programs have merit, they need to be paired with a 529 savings plan that is easy to use, well designed, and offering solid and low-priced investment options. States promote their plans to residents, and additional incentives may entice savers to settle for an in-state plan that may be subpar. Still, if done right, these programs have the potential to help more families seek, plan, and pay for higher education.