President Obama is proposing a radical change to the 529 college savings plans held by millions of families, which would require those who use them to rethink their approach to college savings.
As part of his plan to simplify the tax code and help the middle class, one of the 529 plan’s most attractive benefits would be eliminated: Money could no longer be withdrawn tax-free. (The new rules would apply only to new contributions.)
The accounts, many of which are run by the states, allow people to make contributions that grow tax-free. The money can be withdrawn without the paying of capital gains taxes as long as the proceeds are used for education expenses. Many states provide state income tax deductions for contributions as well.
“I was very surprised by the Obama 529 proposal because in many ways it is anti-middle class for families trying to afford college,” said Joe Hurley, founder of the SavingforCollege.com website. “And so much of the emphasis in the Obama administration has been pro-middle class.”
But some experts said 529 plans, which are used by seven million families and hold $217 billion, disproportionately benefit the most affluent families, which can afford to save. More than 12 million accounts are in circulation, according to Strategic Insight, an investment consultant that tracks the industry. If more affluent families can afford to start saving early and often, the compounding over time enables them to avoid paying more taxes, especially those in higher tax brackets.
“They primarily provide a subsidy to people who would save in other forms anyway,” said Sandy Baum, a senior fellow at the Urban Institute.
The proposed changes — which many experts say would be difficult to pass in a Republican-controlled Congress — would discourage savers from using the accounts because the withdrawals would be taxed as ordinary income. Because that income will be recognized on families’ tax returns, it is also likely to reduce how much they may receive in federal financial aid, said Mark Kantrowitz, publisher of Edvisors.com, since they will be expected to contribute more.
Mr. Hurley of SavingforCollege.com said he would expect 529 contributions to dry up immediately, which would hurt the plans’ financial positions. “States that are not able to retain sufficient assets in their 529 plans will have a difficult time keeping their plans open,” he added.
Even if many middle-income families save in 529 plans, an administration official, referring to the Federal Reserve’s Survey of Consumer Finances, said that more than 70 percent of the account balances for 529 plans and another option known as Coverdell Education Savings Accounts are held by families with incomes over $200,000. (Those figures also include health savings accounts, but still provide a reasonable best estimate, the administration said.) A report from the Government Accountability Office found that a small percentage of families use 529 plans and Coverdell accounts. And those that do use them have a median income that is three times the median income of families without the accounts.
President Obama is proposing a radical change to the 529 college savings plans held by millions of families, which would require those who use them to rethink their approach to college savings.
As part of his plan to simplify the tax code and help the middle class, one of the 529 plan’s most attractive benefits would be eliminated: Money could no longer be withdrawn tax-free. (The new rules would apply only to new contributions.)
The accounts, many of which are run by the states, allow people to make contributions that grow tax-free. The money can be withdrawn without the paying of capital gains taxes as long as the proceeds are used for education expenses. Many states provide state income tax deductions for contributions as well.
“I was very surprised by the Obama 529 proposal because in many ways it is anti-middle class for families trying to afford college,” said Joe Hurley, founder of the SavingforCollege.com website. “And so much of the emphasis in the Obama administration has been pro-middle class.”
But some experts said 529 plans, which are used by seven million families and hold $217 billion, disproportionately benefit the most affluent families, which can afford to save. More than 12 million accounts are in circulation, according to Strategic Insight, an investment consultant that tracks the industry. If more affluent families can afford to start saving early and often, the compounding over time enables them to avoid paying more taxes, especially those in higher tax brackets.
“They primarily provide a subsidy to people who would save in other forms anyway,” said Sandy Baum, a senior fellow at the Urban Institute.
The proposed changes — which many experts say would be difficult to pass in a Republican-controlled Congress — would discourage savers from using the accounts because the withdrawals would be taxed as ordinary income. Because that income will be recognized on families’ tax returns, it is also likely to reduce how much they may receive in federal financial aid, said Mark Kantrowitz, publisher of Edvisors.com, since they will be expected to contribute more.
Mr. Hurley of SavingforCollege.com said he would expect 529 contributions to dry up immediately, which would hurt the plans’ financial positions. “States that are not able to retain sufficient assets in their 529 plans will have a difficult time keeping their plans open,” he added.
Even if many middle-income families save in 529 plans, an administration official, referring to the Federal Reserve’s Survey of Consumer Finances, said that more than 70 percent of the account balances for 529 plans and another option known as Coverdell Education Savings Accounts are held by families with incomes over $200,000. (Those figures also include health savings accounts, but still provide a reasonable best estimate, the administration said.) A report from the Government Accountability Office found that a small percentage of families use 529 plans and Coverdell accounts. And those that do use them have a median income that is three times the median income of families without the accounts.
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