Money & Policy

Obama Wants to Reduce Tax Breaks for 529 Plans

New contributions couldn’t be withdrawn tax-free

(This article appeared previously on MarketWatch.)

President Barack Obama has just proposed a major change to 529 college-savings plans — removing a tax benefit that has attracted parents to these investment vehicles for years.

The president’s State of the Union address Tuesday night, and details provided to the media, included a long list of proposed tax changes. Among them: no longer allowing earnings on new contributions in 529 plans to be withdrawn tax-free.
If that became law, it would be a major revision to 529 plans, and plan experts say such a change would likely result in contributions to these plans declining substantially. "Contributions would dry up in 529 plans," says Joe Hurley, founder of Savingforcollege.com, which tracks 529 plans.

(MORE: The State of the Union and Americans 50+)

Other College-Savings Plans, Too
President Obama’s proposal would allow the earnings on new contributions to grow tax-deferred, but treat them as ordinary income when withdrawals for expenses are made. (Earnings on contributions that have already been made were not part of the proposal.) The same changes would apply to 529 prepaid tuition plans under the president’s proposal.
The president also expected proposed a similar change for Coverdell education savings accounts, which allow earnings to be withdrawn tax-free for qualified expenses, too. Coverdells can be used for higher-education expenses as well as for school costs starting from when the child is in kindergarten. 
Should the president’s proposal go into effect, the change wouldn’t be brand new. When 529 plans launched in the 1990s, earnings withdrawn from the plans were taxed as ordinary income. The Economic Growth and Tax Relief Reconciliation Act that was signed into law in 2001 provided a temporary change to their tax treatment — which became permanent in 2006.
AnnaMaria Andriotis reports on consumer credit and banking for The Wall Street Journal. Follow her on Twitter @AAndriotis.

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