The editors of the Wall Street Journal weigh in on President Obama’s plan to finance his “free” two years of college by taxing college savings plans:
President Obama is pitching his new tax plan as a way to help the middle class at the expense of the rich. But middle-class savers are bound to notice if he achieves two of the White House’s stated goals—to “roll back†tax benefits of 529 college savings plans and “repeal tax incentives going forward†for Coverdell Education Savings Accounts.
Both plans allow parents, grandparents or anyone looking to help fund a kid’s education to contribute after-tax dollars into accounts that grow tax-free. There is also no tax when the money is withdrawn, provided it is used for qualified educational expenses such as tuition, fees, books, room and board.
Mr. Obama wants to allow the IRS to tax as income any withdrawals from future 529 contributions. This would make them less attractive. The White House goal seems to be to discourage private thrift, and encourage greater use of government benefits, when paying for college.
It’s actually worse than that. These vehicles for saving would become useless. The earnings on them are practically nonexistent as it is and then subjecting both the earnings and principal when withdrawn to tax? The only reason to use them under these circumstances would be if you expected your income to be substantially less when you withdrew the money than when you put it in.
The earnings on them are practically nonexistent as it is and then subjecting both the earnings and principal when withdrawn to tax?
No way. They can’t mean to tax the principle (which has already been taxed), too.
Here’s what they say in the editorial:
Since withdrawals would presumably include principle and interest, that’s what it sounds like to me.
However, this is also troubling: “future 529 contributions” would seem to distinguish between present accounts and future ones. Sounds like a mess to me.
Might as well put the money in a savings account.
The whole thing strikes me as the sort of idea one of his PR dudea thought up in a “this will sound progressive!” moment. I suspect Obama isn’t particularly interested in seeing it actually become legislation.
I’m pretty sure that statement in the editorial was a poorly written attempt to say that the earnings would be taxed as regular income at the time of withdrawal.
I’m pretty sure that statement in the editorial was a poorly written attempt to say that the earnings would be taxed as regular income at the time of withdrawal.
That’s what I assumed it has to mean. But it is possible that the President’s speech wasn’t well phrased, either. Seriously, if they mean taxing the principle twice, there would be no reason at all to invest in one of these plans, and every reason not to.
Ben, I’ve already seen an article on either Slate or Salon talking about how wonderful and wise this policy is, because really, the people investing in these plans are all really rich anyway, and the additional taxes will go to all the rest of us! Woo hoo! I still haven’t seen that anything in the President’s proposals will benefit me and mine, but they hate straight white married people anyway, unless they’re rich, so they don’t give a shit about us. But I guess that it is important that snotty writers for Salon & Slate get theirs.
And as Ben pointed out, this has zero chance of getting passed, and they all know it. It’s just more bullshit so the President can pose as though he’s against the rich (who are far and away the main beneficiaries of his Presidency) and for the middle-class (who have taken it up the ass during his Presidency while he makes sure Warren Buffet and George Soros got theirs.)
Yes it clearly has no chance of passing, so I’m not overly concerned for the near future-but as we have 529s for all of our kids, I can’t help but think “BOHICA”. And the part Dave cited about existing plans not being affected gives me comfort because, well, it’s like when Obama promised we could all keep our health insurance plans if we liked them….oh, wait…
The benefits of a 529 savings account are (a) tax-deferred savings, and (b) no tax consequences for withdrawals for qualified educational expenses. Non-qualifying withdrawals are taxed as income, not capital gains, though I believe it is the gain that is taxed not the total withdrawal. However a 10% penalty may apply for non-qualifying withdrawals, unless an exception applies like a scholarship. Seems like an odd combination of capital gains and income tax concepts, who knows what the imaginary proposal would do.
The odd thing to me as I’ve thought about this is that the tax code provides a deduction for student loan interest. The deduction reduces income by up to $2,500. I’m not sure I understand the specific plan (that won’t be enacted), but could it be that borrowing is tax-advantaged over savings? Millennials like to point out the the federal government is making money off the student loan program. If I were a cynic . . .
A website dedicated to 529s explains that under Obama’s plan, only the “earnings portion of the withdrawal will incur income taxes even when the money is spent on college. The principal portion, which is the amount you originally put in, will not be taxed since it is made up of after-tax money.” Link
“earnings portion of the withdrawal will incur income taxes even when the money is spent on college.”
Maybe I’m missing something, but if that’s the case then there doesn’t seem to be any difference between a 529 and a regular savings account except you don’t pay taxes until money is withdrawn. The proposal seems to make 529 accounts largely worthless. And since the proposal would “grandfather” existing contributions, there would be a huge rush to put as much money into these before the law came into effect which would benefit wealthy people. Maybe I’m missing something, but this proposal doesn’t make any sense.
To Andy’s point- the only other remaining distinction would be potential state tax exemption on the earnings. It’s ironic that the name of these investment accounts will be made meaningless if the proposed change is made- “529” comes from the legislation that established the federal tax exemption.
The history, for those unaware, was that the states had created various instruments (during 80s and 90s) for prepaid tuition and/or state tax exemption for education savings. The IRS was contesting much of it (the prepaid tuition accounts were considered contracts with tax implications for the benefits) and there was the problem of parents who wanted the money to be portable instead of specific to one university or state system. I lived in FL at the time and remember Bob Graham being part of an effort to transform the whole concept into something more like an education IRA.
And unlike retirement IRA’s, the deferment of the tax event itself isn’t a benefit in most cases (most people are at or near their highest earning period at the time these funds will be withdrawn, unlike retirement when you’re likely to be in a lower bracket.) so yeah, basically this proposed change would make the accounts pointless (except perhaps in states with high state tax) and they’d probably just cease to exist.
That would be better than what was reported in the WSJ. However, given that the earnings are practically nothing as it is, taxing the withdrawal of interest renders the accounts even more like stuffing the money into your mattress than it would have been otherwise.
They are basically mutual fund accounts, not interest bearing savings accounts….so I wouldn’t say that the proceeds are “practically nothing.”
Our 10 year return on oldest child’s account is over 10%; currently have hers in conservative funds so annual return is 1.8%. Younger kids accounts have recently been earning 6%/year.
And since the proposal would “grandfather†existing contributions, there would be a huge rush to put as much money into these before the law came into effect which would benefit wealthy people. Maybe I’m missing something, but this proposal doesn’t make any sense.
It’s only pointless if you assume they’re really trying to accomplish anything other than Voguing. (“Strike a pose”!)