Hasty Retreat on 529 College Savings Plans

The Obama administration dropped its plan to tax 529 College Savings Plans after detractors said it would hurt, not help middle-class Americans.

The Obama administration dropped its plan to tax 529 College Savings Plans after detractors said it would hurt, not help middle-class Americans.

The Obama administration beat a hasty and tactical retreat by yanking its idea to tax 529 College Savings Plan investment earnings. The proposal drew bipartisan barbs in defense of the popular college savings accounts available in most states.

Obama spokesperson said the 529 plan tax proposal was scrapped to allow the focus to remain on other parts of the President's higher education initiative, especially free tuition for two years of community college paid for by an increase in the federal capital gains tax. They also said the tax revenue from the proposal wasn't that large anyway.

However, the pressure to dump the idea was intense. Republicans, led by House Speaker John Boehner, said eliminating the tax-preferred status of 529 College Savings Plans would hurt middle-class Americans. House Democratic Leader Nancy Pelosi said pretty much the same thing as she rode with President Obama on his Air Force One flight from India to Saudi Arabia.

529 College Savings Plans vary from state to state, but essentially allow contributors — usually parents and grandparents — to put money into an account for a student and receive a tax break. The earnings on money in the student's 529 account aren't taxable as long as they are withdrawn down the line for a qualified educational expense.

Data shows that 80 percent of the tax benefits from contributions to more than 7 million existing 529 plan accounts go to households with more than $150,000 of annual income and 70 percent to households earning more than $200,000. Defenders of 529 plans say 10 percent of contributions are attributed to households with $50,000 or less in annual income, which means the program also works as an incentive for lower-earning households.

Obama's proposal sought to redirect tax benefits associated with college expenses to an expanded American Opportunity Tax Credit, which started in the 2009 economic stimulus bill as a tuition credit aimed at helping families paying for college, even if they didn't earn enough to pay federal income tax. The Government Accountability Office ran estimates showing Obama's plan would drive more economic benefits for families with $100,000 or less in annual income than the current 529 plan benefits.

“It’s kind of baffling that people in the middle are convinced they are getting hit hard when virtually all of them are the winners,” Robert Greenstein, the president of the liberal Center on Budget and Policy Priorities, told the New York Times.

However, that was lost in the political furor Obama's plan ignited.

529 plans are popular in part because they are a fairly easy way to transfer wealth from one generation to another. Tax benefits aren't always the primary motivating reason for the contributions. Threatening these plans showed their broad-based acceptance and popularity by many middle-income families and households.