Building wealth using 529s for K–12 education

A recent Vanguard research paper, It’s Elementary: Using 529s to Pay for K–12 Education, by Amanda Kane, Jonathan Kahler, and Bryan Hassett, explores the impact of using 529 plans to pay for K–12 education. “Using 529 plans for K–12 education is a great way to build wealth through tax savings, but investors should remember that the primary purpose of 529s is to save for college,” said Kahler, head of Vanguard Personal Investor 529 Investments.

Expanded use of 529s

The 2017 Tax Cuts and Jobs Act expanded the Qualified Tuition Program (QTP) rules to allow 529 plans to be used for primary and secondary (K–12) education. These changes allow investors to withdraw up to $10,000 per year or the cost of tuition, whichever is less, to pay for K–12 tuition without incurring federal taxes or penalties.1

Most states also have adopted the federal tax law and allow 529 plan assets to be withdrawn for K–12 tuition without incurring state taxes or penalties, and many states also offer tax deductions or credits for 529 contributions. Eleven states, however, do not consider K–12 tuition a qualified expense.2 In these states, withdrawing funds for K–12 tuition may incur taxes or penalties at the state level.

Opportunity to generate additional wealth through tax savings

To measure some of the benefit of using a 529 plan for K–12 tuition expenses, Kane, Kahler, and Hassett built a model to estimate the excess wealth a hypothetical investor can generate by investing in a 529 instead of a taxable brokerage account.

The authors found that using a 529 plan for K–12 tuition expenses can generate additional wealth through tax savings, particularly for investors who start saving early and reside in a state with favorable tax treatment for K–12 withdrawals. Specifically, the average additional wealth created over 18 years of investing in states that offer a tax deduction is more than 2.5 times the savings in states that do not offer one or in states that penalize K–12 withdrawals.

But what’s interesting is that (with the exception of Minnesota), using a 529 for K–12 tuition can generate additional wealth even in states that penalize using 529s for this purpose. “A big reason for this is the tax-deferred growth and tax-free withdrawals at the federal level,” said Kane, a Vanguard investment analyst. “This is especially the case for those who start early in the beneficiary’s life, as it allows them to take full advantage of tax-deferred growth.”

While our model shows additional wealth creation through tax savings even in most states that impose a penalty, the model relies on a specific set of contribution and investment assumptions. Investors should consult a tax professional before using a 529 plan for K–12 tuition given the nuances involved in each state’s tax code.

Additional wealth created by state over 18 years by using a 529 plan for K–12 tuition

Notes: This model reflects the additional wealth created for a hypothetical investor who is married filing jointly with an annual income of $150,000. The investor contributes $6,100 annually for 18 years and withdraws $10,000 annually for 13 years of K–12 tuition, beginning when the beneficiary is age 5. Additional wealth is defined as the amount an investor can generate by using a 529 plan versus a taxable brokerage account. K–12 allowed with tax deduction refers to states that allow 529 withdrawals for K–12 education and offer a tax deduction. K–12 allowed refers to states that allow 529 withdrawals for K–12 education and do not offer a tax deduction. K–12 penalized refers to states where 529 withdrawals for K–12 education are penalized; penalties vary by state. Tax savings are assumed to be reinvested with an income return of 3.41% and a capital return of 1.16%. Calculations are as of September 6, 2023. (Source: Vanguard.)

Saving for post-secondary education expenses should still be the priority

After measuring the hypothetical benefit of using a 529 plan for K–12 tuition, the team looked at how real-life investors are actually using 529s to pay for K–12 tuition.

The research found that while investors making withdrawals for K–12 tuition were contributing more on average, the contributions were often not enough to both offset withdrawals and build college savings. As a result, these account balances were generally significantly lower compared with those of investors not using the account to pay for K–12 tuition. This was particularly true for those who opened accounts after the federal tax law changed in 2017.

Our findings suggest that investors may be prioritizing the short-term benefits of using these accounts for K–12 tuition, potentially at the expense of their post-secondary education savings goals. (Note that 529 assets may also be used to pay for other types of post-secondary education, like vocational schools or trade schools.)

Because one of the most valuable benefits of a 529 plan is tax-deferred growth, Kahler said that using the account to save for post-secondary education expenses should remain the priority as this goal has a longer time horizon and therefore can generate more additional wealth over time.

Source: Amanda Kane, Jonathan Kahler, Bryan Hassett, Vanguard Group