Jun 1, 2006 12:00 PM

, Vincent C. Travagliato, executive director, and Michael T. Lippincott, associate, Morgan Stanley Pri

Vincent C. Travagliato, executive director, and Michael T. Lippincott, associate, Morgan Stanley Pri

The primary and most tangible benefit of a 529 plan is the tax-deferred growth of the assets in the plan (growth is tax free to the extent the plan assets are used for tuition.) (See “529 Basics,” p. 55.) But this benefit must be weighed against the 529 plan's associated costs. The cost easiest to quantify is the administration fee that, along with other incidental charges like custody fees, vary, sometimes widely, by state. How the use of a 529 plan compares to saving for higher education outside of such a plan depends, at least in part, on the assumptions made about the investment performance, taxation of the assets outside of the 529 plan and the 529 plan administration fees.

We crunched the numbers, comparing saving for the costs of college (1) using a 529 plan, when the investment grows free of income tax but subject to plan administrative fees, and (2) outside of a 529 plan, when the investment is subject to current taxation (but, obviously, is free of the 529 plan administration fee). We found that whether a 529 plan makes economic sense depends on assumptions about things like tax rates, turnover and 529 plan fees — all of which are hard to predict. The 529 plan does enjoy an advantage over taxable accounts. But that edge is eroded when 529 plan fees are high and turnover outside of a 529 plan is low. Adding estate planning into the mix is a complex exercise without a clear answer, although the availability of the Internal Revenue Code Section 2503(e) exclusion for educational expenses is a factor militating against use of the 529 plan. Ignoring estate planning, however, the outperformance of 529 plans is reasonably consistent due to the income tax advantages of such accounts. That, coupled with the intangible benefits likely to be enjoyed by both the donor (for example, paying for a loved one's tuition) and the beneficiary (for example, knowing such tuition will be paid), may make use of a 529 plan attractive.