Obama’s Proposed Changes to 529 Plans

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.

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