Part of President Obama’s proposal to “simplify the tax code” includes significant changes to the tax treatment of 529 plans and Coverdell ESA accounts: for new contributions (i.e, after enactment of this proposal, should that happen) distributions would no longer be tax-free, even if they are used for qualified education expenses. The proposal doesn’t just remove benefits; it also expands the American Opportunity Tax Credit and eliminates the tax on student loan debt forgiveness under certain income-based repayment programs.
The logic behind the proposal is this: Improving the education tax credits (which are scheduled to expire in 2017 under current law) increases the benefit to students from middle-income families, given the income caps in place. 529 plans and Coverdell ESAs disproportionately benefit students from wealthy families, since 70% of assets in the plans are held by families with incomes above $200,000, per the Federal Reserve. In addition, the increased tax revenue from plan withdrawals would help fund the President’s proposal to provide two years of community college free.
Before you start to yell and scream that this is extremely unfair, a couple of things:
- Read Savingforcollege.com’s article on the many reasons that this proposal is highly unlikely to be enacted.
- Remember that this would only apply to new contributions to these plans, after the proposal is enacted. If that isn’t a good reason to up your plan contributions sooner rather than later, I don’t know what is.
According to a recent study by Nerdwallet, here, only about half of high school seniors completed the FAFSA in 2013. Admittedly not all high school seniors go on to college, but much of the aid that is awarded through the FAFSA, including Pell Grants, can be used to pay community college and vocational school costs.
In addition, you need to complete the FAFSA in order to be eligible for federal loan programs including Stafford and PLUS loans.
Nerdwallet estimates that failure to complete the FAFSA resulted in over $2.9 billion in free (i.e. grant) money for college being left on the table. So although you may have plenty of company if you choose not to complete the FAFSA, it would not be good company to be in.
It’s too late, right? Not if you live in Oregon. In Oregon (and several other states) you can make a state-tax-deductible contribution to your 529 plan up until you file your 2014 taxes. If you do make a contribution in the first part of 2015, it’s generally best to take the deduction for 2014. Not only do you get the tax benefit sooner, but you leave your 2015 deduction available too. Remember, you can carry forward excess contributions, but you cannot apply them retroactively to past years in which you didn’t make the maximum.
Every year, the FAFSA undergoes some minor changes, and this year is no exception. One of the big changes is a new login process so that you do not need to enter personal information such as birthdate and Social Security number to log into the system. Instead, you’ll be given an FSA ID that will work as user name and password. Other changes affect Pacific Islander applicants and applicants in foster care; this article on Fastweb details those and other changes.
Those are the surface changes. If you pull back the hood and start looking at the formulas, there’s another change going on that might impact many families. Here’s how: Every year, the income and asset allowances (the part of your income and/or assets that is not counted in the formulas) are adjusted. The normal trend line would have these amounts increasing for inflation, and that is the case for the Income Protection Allowance, Social Security tax allowance, and business/farm net worth adjustment. Here is how the Income Protection Allowance has changed over the past couple of years, for a family of 4 with 2 college students:
- 2013-2014: $23,370
- 2014-2015: $23,840
- 2015-2016: $24,030
That makes sense; we have some level of inflation so some additional income is required to keep our heads above water.
The Asset Protection Allowance, however, is moving in the opposite direction, at a time when more and more savings are required to afford college. Here are the Asset Protection Allowance numbers for a two-parent household with the oldest parent being 45:
- 2013-2014: $36,200
- 2014-2015: $30,700
- 2015-2016: $28,200
Refresher course: the Asset Protection Allowance is the amount of your (non-retirement) assets that are excluded from the EFC calculation. Any amounts over that are assessed at 5.62%, i.e. every $10,000 above the APA would translate to an additional $562 available to pay for college.
Is this trend likely to continue? Yes. Does it mean to stop saving for college? No. As discussed, every $10,000 in assets you have above the asset protection allowance only increases your EFC by about $562, so you’re still coming out ahead by a long shot. The penalty for having assets available to pay for college is peanuts compared to the penalty for not having any.