BERKO: College 529 plan safe for now from the taxman

By: Malcolm Berko//April 21, 2015//

BERKO: College 529 plan safe for now from the taxman

By: Malcolm Berko//April 21, 2015//

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DEAR MR. BERKO: How does one define “middle class”? Both my wife and I work. We are college-educated, and we have 529 plans for our children, who are 11, 13 and 16. We’ve been told that the government wants to tax future withdrawals from 529 plans to help middle-class Americans afford their college costs. I think of us as a middle-class family. During the past 16 years, we have invested over $70,000 in these 529 plans, and taxing the withdrawals from them would make it more difficult for us to help our children get the best education we can afford for them. – MA, Erie, Pa.

DEAR MA: A dozen others have expressed similar concerns. I asked Patrick, my 54-year-old certified public accountant, whom I’ve known for many years, how he defines “a middle-class family.” Patrick describes that family as wage earners who live comfortably on what they make and who pay their credit cards and other bills when they come due. A middle-class family can put aside some earnings for retirement, save enough to help the kids through college and take annual vacations without borrowing. There are not a lot of families who meet those criteria today. And if that’s the definition of “middle class,” then our numbers and our influence are declining and America is in deep doo-doo. When I told Pat that less than 15 percent of American families have those capabilities, he agreed, saying that workers have learned to depend on Santa Claus in Washington and elves in their home states to pass out checks. But leapin’ Jack Flash, you and many readers are jumping to confusion.

For those who are uninformed, 529 plans are tax-advantaged savings accounts via which families invest to pay for their kids’ future college tuition and related costs. The contributions are usually immune from state taxation, and under current law, the accumulated earnings can be withdrawn tax-free if they are used to pay for college costs.

President Barack Obama’s February budget submission to Congress called for some big ideas, one of which was a rollback of the tax exemption on 529 plans. This proposal was supposed to pay for the Obama administration’s plans to increase education-related tax breaks for those without resources to fund 529 plans. The rationale behind this proposal was the administration’s belief that only affluent households can afford 529 plans. But this well-meaning foray into social engineering, to help those who can’t afford a college education, hit unexpected speed bumps on the way. The backlash among Democrats and Republicans was surprisingly so swift and fierce that Obama reneged on the proposal, suggesting it was a distraction to the rest of his education plan. Oftentimes I think the government wants to tax our taxes. The administration is now considering an alternative in the form of a value-added tax, which is a type of consumption tax that is popular in Europe. And because other readers are concerned about a VAT, I’ll address this in a future column.

There are currently about 12 million individual 529 accounts managed by state governments, with an estimated $240 billion in assets. The administration’s proposal was intended to level the playing field, believing it could achieve socially desirable goals through various tax carve-outs. And as mentioned in a past column, Congress would like to means-test Roth IRAs and tax those whose owners’ assets exceed a certain level.

The problem with social engineering is that the process soon runs out of other people’s money. Most don’t believe that Congress would tax their Roth IRAs. But most Americans didn’t believe that Congress would tax their Social Security benefits. Treasury Department rulings in 1938 and 1941 had forbidden the taxing of Social Security, and a further clarification in 1970 had explicitly excluded SS from federal taxation. I’d had strident discussions on this subject with Ross Perot, who ran DuPont Walston in 1980, and George Ball, CEO of E.F. Hutton in 1982. Neither believed that the federal government would tax SS. These guys just didn’t realize that it takes a lot of money to trust a congressman. In 1983, taxing legislation was finally approved, and SS payments became taxable in 1984.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at [email protected].

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