OR 529 Part 2: Which is Better?

The follow-up question to the Oregon College Savings Plan tax change is: Am I better off with the 2020 tax benefit or the 2019 one? The answer, as is so often the case, is “it depends.”

To recap: The current plan offers a tax deduction for contributions up to $4,870 (married filing joint; half for single filers) in 2019. With marginal income tax rates of 5%, 7%, 9% or 9.9%, a family that contributed the maximum would get a deduction worth between $243.50 and $482.13. (However, with the 9% bracket beginning at $17,400 of taxable income for MFJ, most families contributing to the Oregon College Savings Plan who max out would save at least $432.) This remains in effect for contributions made through Dec. 31, 2019, including excess contributions that can be carried forward and deducted over the next four years.

Beginning Jan. 1, 2020, contributors will receive a tax credit of up to $150 (single) or $300 (MFJ) for their contribution. The percent of contribution eligible for the credit ranges from 100% to 5%, depending on income. For those with Adjusted Gross Incomes below $30,000 (single or MFJ), 100% of contributions are eligible, up to the $150/$300 maximum. So a $150 or $300 contribution will get a tax credit equal to the contribution. For those with AGIs between $100,001 and $250,000, only 10% of contributions are eligible for the credit, meaning that a family will need to contribute $3,000 to get the maximum tax credit. Incomes above $250,000 get credit for only 5% and thus would need to contribute $6,000 to maximize the credit.

At first blush, this looks like a really bad deal: the tax benefit has gone down by about 1/3 for most families. However, in a recent meeting with the Oregon College Savings Plan during which we asked why families could not deduct higher contribution levels, plan representatives told us that only a very small fraction of contributors are getting the maximum tax deduction. So maybe that’s not the best comparison point, but rather a rationale for the change.

Instead, let’s look at a typical household in the $100,000-$250,000 AGI range. With two children, they might be contributing $100-$200 per month to the plan for total annual contributions of $1,200 to $2,400. Under the old system, that family would receive a deduction worth 9% of their contribution, or $108-$216. Under the new system, the family would receive a tax credit worth 10% of their contribution, or $120-$240. So even though the rate appears lower, the benefit for many– if not most– families will be at least slightly greater.

The benefit is even more substantial as you go down the income scale: A family with income below $30,000 would effectively get up to $300 of free money for college annually insofar as they would get a $300 tax credit for their first $300 of contributions to the plan. And the tax credit is refundable, meaning that if you do not owe income taxes, you will receive a refund for the amount of the credit. That’s actually pretty cool.

The people who lose out? Higher income families who can currently get a $482 tax savings for a $4,870 contribution. Starting next year, they’ll need to contribute $6,000 to get a $300 tax credit.

But remember, anyone with earned income can contribute to the plan and get the tax benefits. All that’s required is to file an Oregon tax return. So your teenager can contribute $150 from their own account and get a $150 tax credit. In the above example of the higher-income family, if two children each contribute $150 to their account, the family’s total tax savings would be $600 for $6,300 in contributions– dollar-wise a greater tax savings, although slightly less than the current 9.9% rate. Even better, families wanting to have it both ways, so to speak, are welcome to do so for the next four years: You can both carry forward excess contributions and take the tax credit for new contributions.

So: Higher-income families– especially those with income above $250,000– are likely to benefit from making the largest possible contribution before the end of the year. Lower-earning families should consider how much they’re contributing and calculate based on that whether they should try to get additional contributions in now, or whether they’re better off waiting.

There’s one qualification to the carry-forward benefit: You can only take the deduction if the account balance at the end of the year in which the deduction is taken is greater than the deductible amount. This means that if your youngest student is already in college, you probably only want enough carry-forward contributions to get you through the tax year ending Dec. 31 of their senior year in college.

And of course there’s a catch to the tax credit brackets, too: Unlike tax brackets, where your next dollar earned is taxed at the higher rate but dollars up to that point are taxed lower, in the tax credit plan your income determines what percent of contributions are eligible. So if your AGI was on track to be $99,999 (which would put you in the 25% eligible bracket) and you got a $100 bonus at the end of the year, you’d suddenly find yourself in the 10% eligible bracket. If you had made $1,200 in contributions, your $300 tax credit would drop to $120, meaning your $100 bonus cost you $180. That’s a little extreme, but something that people with variable incomes should factor into their planning.

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