Stop Obama From Taxing 529 College Savings Accounts
529 Plans Help Slow Growth of Student Debt
The U.S. is experiencing the worst student debt crisis in history due in large part to the rising cost of higher education. These costs are sending more students than ever to loans. In its ninth annual report on student loan debt, the Institute for College Access and Success found nearly seven in 10 graduating seniors in 2013 left school with an average of $28,400 in student loan debt, an increase of 2 percent from 2012.
A 529 plan is an investment account in which you deposit after-tax money. Earnings on your investment grow tax-free, and you don't have to pay income tax when you withdraw the money as long as it is spent toward qualified educational expenses. Under the president's proposed plan, 529 accounts would become taxable, with the earnings portion of the withdrawal incurring income taxes even when the money is spent on college.
Why is Obama proposing to break one of the best tools that motivates families to save for their children's college education -- in many cases starting from when they are infants? If Congress ever passes such a proposal, I believe it will further increase the level of mile-high student debt and also hurt young workers' ability to save for retirement.
Saving for a Stepchild's College Education
Let's take my stepdaughter's account as an example. I have contributed $18,000, and the account is now worth $24,000. That $6,000 gain has come quicker than had I invested in a taxable brokerage account since the investment gains accrued tax-free, similar to a Roth IRA. Under the existing 529 plan rules, no portion of the money (neither the contributions nor the investment earnings) will be taxed if Rachel uses the money for qualified educational expenses.
According to Savingforcollege.com's Annual College Savings Survey, 59 percent of people who intend to open a 529 plan say that federal tax benefits are one of the top three reasons for doing so. Had the president's proposal been law at the time I considered opening a 529 account, I wouldn't have opened it. Why would I tie up after-tax money in an account limited to only educational expenses on which I would have to pay taxes on the earnings? I'd rather have the flexibility to save and spend that money on anything such as unexpected medical expenses. If the president's proposal become law, in my financial advisory and investment education practice I'd advise clients to skip 529 plans when saving for college.
Do 529 Plans Benefit the Affluent at the Expense of the Middle Class?
Some experts believe 529 plans, which are used by about seven million families, disproportionately benefit affluent families. According to surveys cited by the White House, 70 percent of 529 account assets are held by families earning over $200,000 per year. According to Robert Greenstein, of the Center for Budget and Policy Priorities, "The president's plan would limit a number of inefficient tax benefits that are heavily tilted toward upper-income families, including those for 529 plans." He adds, "Scaling back the 529 tax subsidy for high-income filers and redirecting the funds towards low- and middle-income filers who most need support to afford higher education is sound policy that would make higher education more affordable for more low- and middle-income families."
In my practice, I see plenty of people who are not affluent using 529 plans to help save for their children's education.
Let Your Voice Be Heard
The White House takes feedback using an online petition platform. If you wish to keep 529 plans tax-free (only future contributions would be subjected to the tax), you can add your name to this petition. Although it is highly doubtful the Republican Congress would pass the president's proposal, let your voice be heard.