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529 plans get attention, but participation still lags

The 529 college savings plans have been around nearly 20 years, but they got an unexpected boost this year after President Barack Obama proposed taking away the one of their core benefits.

When Obama revealed his tax plan during the State of the Union address in January, he proposed no longer allowing earnings on new contributions in 529 plans to be withdrawn tax-free.

The backlash from the public and lawmakers, including Democrats, was swift. The administration withdrew its proposal days later and the House passed a bipartisan bill in February that actually expanded tax benefits for 529 plans, allowing college students to use 529 funds for computers and other school-related technology. A companion bill in the Senate unanimously passed the Senate Finance Committee and now awaits a full floor vote.

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Beyond the legislation, the president's failed proposal also helped put the spotlight on the college savings plans. "Some of the publicity with Obama's address started out negative and turned into a positive," said Rich Polimeni, director of education savings programs at Bank of America Merrill Lynch. "It [helped to illustrate] that 529 plans are an extremely important tool for college savings."

Still, despite the publicity, that message has yet to reach most Americans.

Two-thirds of Americans don't know what a 529 plan is, according to a recent survey by Edward Jones, (Tweet This) and Sallie Mae found only 27 percent of families saving for college use 529s, down from 29 percent in 2014.

The state-sponsored plans come in two versions: savings and prepaid tuition plans. Savings plans, which are the most common type of 529, allow your investment to grow tax-free like an IRA. You can avoid taxes completely if you use 529 money to pay for qualified higher education expenses, which include tuition, fees, books, room and board. Prepaid tuition plans let users pay in-state college tuition in advance.

While 529 plans have gotten a lot more attention this year, that has not translated into a big bump in assets. Total 529 savings plan assets were at an estimated $231.9 billion as of March 31, 2015, reflecting a 3.4 percent increase from the fourth quarter of last year and a 10.1 percent rise from a year earlier, according to financial research firm Strategic Insight.

While assets have grown, Paul Curley, Strategic Insight's director of college savings research, said the inflows were "extremely muted"—especially given the political spotlight on the plans. But he added that the attention "might raise awareness for the need for long-term college savings."

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The need to save for college is great, even for those with a 529 plan. Strategic Insight estimates that 11.2 million 529 plan investors held an average balance of $20,617 as of March 31, up slightly from an average balance of $20,474 on Dec. 31, 2014. That's less than the estimated cost of a year at a public four-year college.

During the 2014-15 academic year, the average cost of tuition, room and board at a public four-year college was $18,943, a jump of 3 percent from last year. And at private nonprofit four-year colleges, the average cost was more than double that: $42,419—an increase of 3.6 percent from the previous year, according to the College Board.

For those considering private school, the Private College 529 Plan may be a good option. It has similar tax benefits to 529 prepaid plans that cover the cost of state schools, but lets people lock in future tuition at today's prices at more than 270 private schools, including Stanford University, Georgetown University and the University of Chicago. However, the average plan balance in the Private College 529 Plan is only $38,000, less than a year of private-college costs.

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To combat the high cost of a college education, 529 plan providers say that they are encouraging parents and family members to save earlier for college. "If you wait until the kid is 8 years old, you are already halfway to college at that point," said Nancy Farmer, president of Private College 529 Plan. "Every dollar you save is a dollar you don't have to borrow tomorrow."

More parents are also enlisting friends and family to contribute to 529 plans. "We have seen a tremendous increase in third-party giving," said Derek DeLorenzo, senior vice president at Ascensus College Savings, which administers the 529 plans of New York and nine other states. Ascensus' third-party giving program, called Ugift, lets friends and family members transfer money to 529 plans. Contributions more than doubled to $59.8 million last year from $27.1 million in 2013.

Encouraging early 529 contributions and more giving from friends and family is all about changing the culture of college financing, said Betty Lochner, chair of the College Savings Plans Network and director of Washington state's 529 prepaid plan. "We want to move families from a debt model to a savings model."