MONEY 529 plans

Why Obama Wants to Tax College Savings

U.S. President Barack Obama delivers his State of the Union address to a joint session of Congress on Capitol Hill in Washington, January 20, 2015.
Mandel Ngan—Reuters

In this week's State of the Union address, the president proposed ending a popular tax break on 529 plans. Here's what's behind that pitch.

In his State of the Union address Tuesday, President Obama promised to make college more affordable for low- and middle-income families. But one way he would pay for that would be to make college more expensive for millions of upper-income Americans.

The president proposed ending a key tax break on state 529 college savings plans. Today, the money you invest in a 529 plan isn’t deductible on your federal taxes (34 states and the District of Columbia give you a break on state taxes), but your savings grow tax-deferred, and you won’t owe any taxes on your earnings when you withdraw that money to pay for higher education expenses, including tuition, room and board, and books. Under Obama’s plan, those investment profits would be taxable, even if the money went toward college.

President Obama says he’d use the estimated $2 billion in additional tax revenues to raise the American Opportunity tax credit, which is a $2,500 write-off targeted at low- and middle-income families paying tuition bills. The administration points out that 529 plans disproportionately benefit higher-income households.

In essence, Obama is proposing making college more expensive for an estimated 2 million mostly upper-income families to ease the tuition burden for more than 8.5 million low- and middle-income families.

A Question of Fairness

This proposal—which is already facing Republican opposition in Congress—is based on concerns about the fairness of the 529 tax breaks that have been widely discussed among education-related think tanks and experts of all political leanings for years.

In all, federal taxpayers spend more on educational tax breaks than they do on popular financial aid programs such as Pell grants, noted a 2013 report by the Reimagining Aid Design and Delivery (RADD) Consortium for Higher Education Tax Reform. Not only are all the education tax breaks confusing and hard to collect, “students from families with the least financial need receive the most tax-based aid,” the report noted.

In theory, 529 plans aren’t just for the rich. Anybody can open one of these tax-protected colleges savings account for a child or for themselves. You can choose either a prepaid tuition plan, which lets you buy tuition credits ahead of time, or a college savings plan, which lets you set money aside for a future college student.

That tax break that the president wants to eliminate has been a key to 529 plans’ popularity. Since President George W. Bush signed the 529 tax exemption into law in 2001, families have opened nearly 12 million new 529 accounts and have socked away almost $250 billion for college.

And states have been marketing the savings programs. In 2012, the GAO found that 14 states offered matching grants to encourage low-income families to save. Some states even offered 529 brochures to new parents leaving the hospital.

Despite these efforts, very few low- or middle-income families have managed to save very much in 529s. In 2012, more than 97% of families had no special college savings account, according to a Government Accountability Office report. (The large number of accounts may be due to some families opening separate accounts for each child and parent.)

One reason for the low participation: Many still don’t know about 529s. Of parents who say they’re planning to send their kids to college, 49% don’t even know what a 529 plan is, Sallie Mae found in its annual “How America Pays For College” report.

Another factor: Low and middle-income families pay comparatively low taxes, so the tax break is not much of a lure to lock up money for one purpose. Families can take money out of 529s to spend on non-college expenses, but they’ll have to pay regular income taxes, plus an extra 10% penalty, on any earnings.

As a result, 529 investors tend to be wealthy. Families with 529s earned a median annual income of $142,400 and reported a median of $413,500 in financial assets, according to the GAO. About half of families with 529s (or similar Coverdell accounts) had an income above $150,000 in 2010.

And, in part because high earners typically owe higher taxes, the wealthy reaped large tax breaks from using 529s. In 2012, the GAO found that Americans who made less than $100,000 withdrew a median $7,491 from their 529s, saving just $561 on their taxes. But Americans who earned more than $150,000 withdrew a median $18,039, saving $3,132 in taxes.

In place of the tax break at withdrawal, Obama wants to expand the American Opportunity Tax Credit, which is currently phased out for families earning more than $180,000 a year.

The administration would like to expand the write-off to more students, such as those who attend college part-time. “It’s targeted in such a way that it will be most impactful to the students who need the assistance the most,” says Cecilia Muñoz, White House domestic policy director.

What Changes You’ll Really See

What does this all mean for you: Not much, at least for the near term.

If you’ve already got money in a 529, don’t worry. The president’s plan wouldn’t be retroactive. It would repeal the tax break on earnings only for future contributions.

And if you’re planning to start saving for college, there’s probably not much to worry about either. Republicans, who control both houses of Congress, have come out in opposition to the proposal. “You don’t produce a healthy economy and an educated workforce by raising taxes on college savings,” Brendan Buck, a spokesman for Rep. Paul Ryan, R-Wis., told the Wall Street Journal.

That means there probably won’t be extra money in the budget for much additional financial aid for low- and middle-income families. So you may as well start saving for tuition bills. Here’s how to find the best 529 plan for you.

Correction: An earlier version of this story misstated the proportion of new tax revenues that would come from families earning above $250,000 if Obama’s proposal was enacted. The reference has been removed.

 

TIME Innovation

Five Best Ideas of the Day: January 21

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

1. China’s scramble to lock up resources in Africa has forced it to act more like a conventional superpower.

By Richard Javad Heydarian in Medium

2. Adaptive learning technology can give educators tools to keep kids who learn differently from falling through the cracks.

By Susan D’Auria and Ashley Mucha at Knewton

3. 2015 might be the year America starts to get online identity right.

By Alex Howard in Tech Republic

4. Changing a long-standing rule prohibiting sororities from hosting parties could reverse the power imbalance that underlies campus sexual assault.

By Michael Kimmel in Time

5. Ominous headlines notwithstanding, offline fraud and scams are still more costly to individuals and the government than cybercrime.

By Benjamin Dean in the Conversation

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

TIME Ideas hosts the world's leading voices, providing commentary and expertise on the most compelling events in news, society, and culture. We welcome outside contributions. To submit a piece, email ideas@time.com.

MONEY The Economy

The 2015 State of the Union Address In Under 2 Minutes

President Barack Obama highlighted the recovering economy as well as proposals for free community college, increasing trade with Cuba, and building more infrastructure.

MONEY College

The Problem With Obama’s “Free Community College” Proposal

US President Barack Obama speaks on new proposals for higher education accessibility at Pellissippi State Community College in Knoxville, Tennessee on January 9, 2015. Looking on are US Vice President Joe Biden and his wife Jill Biden.
US President Barack Obama speaks on new proposals for higher education accessibility at Pellissippi State Community College in Knoxville, Tennessee on January 9, 2015. Looking on are US Vice President Joe Biden and his wife Jill Biden. Mandel Ngan—AFP/Getty Images

President Obama's free college plan won't actually raise the number of college graduates without improvements in the way community colleges help students succeed, say two education researchers.

President Obama’s ambitious proposal to make community college tuition free would certainly make enrolling in college more affordable. It may also induce students to stay there longer.

However, reducing costs for students on its own is unlikely to significantly increase the number of students who finish degrees. Consider: Of all of the students who enrolled in public community college for the first time in the fall of 2003, only one-quarter earned any kind of certificate or associate’s degree within six years. Another 12% earned a bachelor’s degree within that six-year period.

If we want to significantly improve educational outcomes, we need to both make college more affordable so more students can enroll, and make the reforms needed to ensure community college students can succeed in their courses, complete their programs, and graduate within a reasonable amount of time.

President Obama’s plan would certainly make community college more affordable. Even for the 40% of community college students whose tuition is already covered by federal and state aid, other expenses (food, transportation, books, etc.) often present insurmountable hurdles. If grants are awarded to eligible students on top of free tuition, as President Obama proposes, then many of these affordability issues would be addressed.

But the Tennessee and Chicago free tuition policies that inspired President Obama also address the broader barriers to success. The affordability improvements in those communities are one part of larger reforms designed to dramatically boost the success of community college students by providing close monitoring of student progress, careful alignment of courses to transfer and job requirements, clearer and more coherent programs of study, and help for students to make better choices about what to study.

Such reforms, many features of which have also been enacted in the City University of New York’s Accelerated Studies in Associate Programs (ASAP), have doubled the graduation rate for participants. But at a cost: ASAP costs 60% more per student than the standard CUNY program.

Laudably, President Obama’s proposal does try to address quality. It includes requirements that community colleges “adopt promising and evidence-based institutional reforms to improve student outcomes.” But his plan does not provide colleges with additional resources to help them in these efforts.

In fact, it is possible that his plan could reduce the money community colleges are able to spend on improving outcomes.

The White House estimates that the free tuition program would cost $6 billion a year. But that money would simply replace the tuition students were already paying, not increase colleges’ revenue. States would be required to pay for one-quarter of this tuition subsidy. Some may raise that money by decreasing the direct subsidies they give colleges now, which currently cover approximately two-thirds of the cost of educating each student.

Despite these obstacles, the president’s proposal opens the door to a broader discussion of a comprehensive strategy for community colleges that emphasizes both affordability and performance.

Community colleges are the launchpad for opportunity for all Americans, enrolling almost half of the nation’s undergraduates. They are especially crucial for those who have, traditionally, been excluded from other kinds of higher education.

For these millions of students seeking brighter futures at community colleges, we need bold and transformative change and renewed public investment to ensure they have college options that are both affordable and of high quality.

Thomas Bailey is director of the Community College Research Center at Teachers College, Columbia University and co-author of the forthcoming Redesigning America’s Community Colleges (Harvard University Press, 2015).

Judith Scott-Clayton is a senior research associate at the Community College Research Center at Teachers College, Columbia University.

TIME Innovation

Five Best Ideas of the Day: January 20

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

1. Is America willing to do the hard work to mend its racial divide?

By Eric Liu in CNN

2. The first new antibiotic developed in 30 years could turn the tide against the rising resistance of many diseases.

By Brian Handwerk in Smithsonian Magazine

3. Adapting to climate change will buy time, but rising sea levels are a major threat to low-lying cities.

By Laura Parker in National Geographic

4. Is four years too much? More college students are jumpstarting careers by graduating early.

By Rachel Rosenbaum in USA Today College

5. The cargo ship of the future will have a hull that acts as a giant sail, slashing fuel consumption and carbon emissions.

By Fraunhofer Center for Maritime Logistics in Phys.org

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

TIME Ideas hosts the world's leading voices, providing commentary and expertise on the most compelling events in news, society, and culture. We welcome outside contributions. To submit a piece, email ideas@time.com.

MONEY College

How to Balance Saving for Retirement With Saving for Your Kids’ College Education

Parents often find themselves between a rock and a hard place when it comes to doing what's best for themselves and their children. One financial adviser offers a formula to make it easier.

It’s a uniquely Gen X personal finance dilemma: Should those of us with young children be socking away our savings in 401(k)s and IRAs to make up for Social Security’s predicted shortfall, or in 529s to meet our children’s inevitably gigantic college tuition bills? Ideally, of course, we’d contribute to both—but that would require considerable discretionary income. If you have to chose one over the other, which should you pick?

There are two distinct schools of thought on the answer. The first advocates saving for retirement over college because it’s more important to ensure your own financial health. This is sort of an extension of the put-on-your-own-oxygen-mask-first maxim, and it certainly makes some sense: Your kids can always borrow for college, but you can’t really borrow for retirement, with the exception of a reverse home mortgage, which most advisers think is a terrible idea.

The flip side of this, however, is that while you can choose when to retire and delay it if necessary, you can’t really delay when your kid goes to college. Moreover, the cost of tuition has been rising at a much faster rate than inflation, another argument for making college savings a priority. Finally, many parents don’t want to saddle their young with an enormous amount of debt when they graduate.

According to a recent survey by Sallie Mae and Ipsos, out-of-pocket parental contributions for college, whether from current income or savings, increased in 2014, while borrowing by students and parents actually dropped to the lowest level in five years, perhaps the result of an improved economy and a bull market for stocks. But clearly, parents often find themselves between a rock and a hard place when it comes to doing what’s best for themselves and their children: While 21% of families did not rely on any financial aid or borrowing at all, 7% percent withdrew money from retirement accounts.

If you’re struggling with this decision, one approach that may help is to let time guide your choices, since starting early can make such a huge difference thanks to the power of compound interest. Ideally, this would mean participating in a 401(k) starting at age 25 and contributing anywhere from 10% to 15%, as is currently recommended. Do that for a decade, and even if your income is quite low, the early saving will put you way ahead of the game and give you more leeway for the next phase, which commences when you have children (or, for the sake of my model, when you’re 35).

As soon as your first child is born, open a 529 or similar college savings account. Put in as much money as possible, reducing your retirement contributions if you have to in order to again take advantage of the early start. Meanwhile, your retirement account can continue to grow on its own from reinvested dividends and, hopefully, positive returns. Throw anything you can into the 529s—from the smallest birthday check from grandma to your annual bonus—in the first five or so years of a child’s life, because pretty soon you will have to switch back to saving for retirement again.

By the time you’re 45, you will have two decades of saving and investing under your belt and two portfolios as a result, either of which you can continue to fund depending on its size and your cost calculations for both retirement and college. You probably also now have a substantially larger income and hopefully might be able to contribute to both simultanously moving forward, or make catch-up payments with one or the other if you see major shortfalls. At this point, however, retirement should once again be the central focus for the next decade—until your child heads off to college and you have start writing checks for living expenses, dorm fees, and textbooks. Don’t worry, you still have another 10 to 15 years to earn more money for retirement, although those contributions will have less long-term impact due to the shorter time horizon.

Of course, this strategy doesn’t guarantee that your kids won’t have to apply for scholarships or take out loans, or that you won’t have to put off retiring until 75. But at least you will know that you did everything in your power to try to plan in advance.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

 

 

 

 

 

MONEY College

Ducks vs. Buckeyes: Bettors Favor Oregon, Employers Prefer Ohio State

Jalin Marshall #17, Corey Smith #84 and Michael Thomas #3 of the Ohio State Buckeyes during Media Day for the College Football Playoff National Championship at Dallas Convention Center on January 10, 2015 in Dallas, Texas.
Jalin Marshall #17, Corey Smith #84 and Michael Thomas #3 of the Ohio State Buckeyes during Media Day for the College Football Playoff National Championship at Dallas Convention Center on January 10, 2015 in Dallas, Texas. Ronald Martinez—Getty Images

Sports fans think Oregon has the better football team, but Ohio state students are more likely to graduate and earn higher salaries.

Bettors are predicting the University of Oregon Ducks will win tonight’s first-ever college football championship against the Ohio State Buckeyes. But according to our research, Buckeyes are more likely to have an edge in life.

A MONEY analysis of the performance of the two colleges indicates that Ohio State students are more likely to graduate, and more likely to find higher-paying jobs, than University of Oregon undergrads:

School MONEY ranking MONEY value-added grade Graduation rate Payscale.com earnings within 5 years
University of Oregon 429 B- 67% $41,000
Ohio State University 144 B+ 83% $46,200

Of course, there are tradeoffs: Buckeyes have to spend their winters in Columbus, Ohio, where the average high temperature in January is just 36 degrees, and they can expect almost 10 inches of rain or snow.

To compare how your favorite teams match up academically, see MONEY’s full Best Colleges list, which ranked the nation’s 665 top schools on educational quality, affordability, and future earnings potential.

More from MONEY’s Best Colleges:
The 25 Best Colleges You Can Actually Get Into
The 20 Best Colleges for Merit Aid
Best 100 Best Colleges If You Need a Student Loan

 

MONEY College

5 Ways to Get Free College Education Even If (When?) Obama’s Plan Dies

Congress probably won't approve the free community college plan, but there are lots of ways you can get free or affordable college courses.

Almost as soon as President Obama floated his proposal for free community college on Thursday night, experts began explaining the political, economic, and practical reasons it was unlikely ever to become a reality.

Chances are slim, it was pointed out, that he can persuade a Republican-controlled Congress to approve and fund the expensive plan

And community college leaders worried about their ability to handle a big influx of students attracted by free courses, some noting that insufficient revenues and high demand have forced some community colleges to turn away students in recent years.

But don’t despair: Many other programs are already making college free for thousands of students. And there are other proposals to eliminate up-front tuition that could open the college gates to more students in the future.

Here are five ways you can find free or very affordable college courses right now:

1) Some states and cities already have free or low-cost community college tuition. The Tennessee Promise, which is the model for President Obama’s plan, waives tuition not covered by other aid programs for students who file a Free Application for Federal Student Aid (FAFSA), donate eight hours of community service each semester, and earn a C grade point average. Similar programs are being debated in Oregon, Texas, Mississippi, and Chicago. Community colleges in California, the most affordable in the country, charge less than $1,500 a year in tuition and fees.

2) Financial aid and tax benefits already cover most community college tuition. The average community college charges about $3,350 a year in tuition and fees. By taking advantage of the $2,500 federal tuition tax credits, as well as financial aid such as the federal Pell Grant, the average community college student gets enough aid to cover tuition and the approximately $1,000 book bill, according to research by the College Board.

3) Alternative free college proposals. Several states are considering “Pay It Forward” proposals that would allow students to attend college without paying any tuition right away and instead repaying a percentage of their income over time. And other “free college” plans have also gained traction.

4) Established free college programs: The military, work colleges, and many generous colleges offer ways to get free college educations.

5) Free online courses: There are hundreds of free Massive Open Online Courses (MOOCs). Many, for a nominal fee, will award you college credits.

TIME Education

New Liberal Rallying Cry: ‘Free Higher Ed For Everyone!’

college homework
Getty Images

President Obama announced Thursday a new proposal to cover the cost of two years of community college tuition for any and all American students who maintain good grades.

While the plan seemed radical to some—and others wondered how the U.S. government would pay for it—the idea of providing access to free higher education has gradually become a mainstream talking point among liberal and progressive intelligentsia in the last few years. Now that healthcare is off the table, the next big liberal agenda item appears to be universal higher ed.

The argument is essentially economic: there is a gaping chasm between the level of education the American workforce has versus the level it needs to qualify for the jobs of today, and of the future. That’s largely because hundreds of millions of working class Americans, who were raised in the 1960s, ’70s, ’80s and even ’90s, didn’t grow up with computers and didn’t get an advanced degree. Instead, they got manufacturing and factory jobs when they graduated from high school. But fast-forward to today and those manufacturing and factory jobs simply don’t exist anymore. The vast majority of jobs available in the current economy require at least associate’s degrees, and more often bachelor’s degrees—not to mention competency online.

It’s that economic reality that has lead people like Robert Shapiro, a former economic advisor for both Clinton and Obama, to suggest that community colleges should offer free, voluntary and regular Internet and information technology classes at night “to any adult in America” who wants it.

“There is a social responsibility and and a large aggregate economic benefit to upgrade all those skills,” Shapiro told TIME in an interview late last year. “And these are not skills for a particular profession; they are general purpose skills. And you could do it easily for under a billion dollars a year because the investment is already there. You’ve already got the computer labs, you’ve already got the computers. This a a traditional mission of the community colleges.”

William Galston, a fellow at the Brookings Institution and a former domestic policy advisor to Bill Clinton, has suggested that the U.S. government should come right out and create a nationwide online public university—the National Online University, he calls it—where anyone could get a degree, in their own time, for free.

Even conservative economists such as Douglas Holtz-Eakin, who served as John McCain’s chief economic policy adviser in 2008 and is now the head of the right-leaning think tank, American Action Forum, have argued that access to higher education (although not free) and reformed skills-trainings to Americans would be a boon for the economy.

The problems, he says, are twofold. One, who’s going to pay for all this free education? And two, how do you explain to lawmakers and taxpayers today that they’re not going to see the immediate effects of this investment?

“The big disconnect between the politics and the policy is the time scale,” he told TIME last year. “You go and talk to [policy] people and they say, ‘We gotta fix the K-12 education system, the higher education system…we have to create lifelong learning and genuine retraining programs.’ And that’s all true. But it won’t affect this core troubling economic phenomenon today.” Programs that provide 20-year-olds the skills they need to compete in the global marketplace are important, he said, “but you’re not going to see the effects of that until 2036.”

Obama’s announcement Thursday fell under immediate criticism from Congressional Republicans. Speaker of the House John Boehner’s spokesman dismissed it as “more like a talking point than a plan,” while Sen. Lamar Alexander, who chairs the Senate committee on education, decried creating a “new federal program.” Alexander suggested instead streamlining existing state programs.

“[I]nstead of creating a new federal program, the federal government can help in two ways. First, reduce federal paperwork for the ridiculous 108-question student aid application form which discourages 2 million Americans from applying for federal Pell grants that are already available to help pay community college tuition,” Alexander wrote in a statement. And second, pay for the millions of new Pell grants that will be awarded if states are able to “reduce federal paperwork” and therefore allow “students to use Pell grants year-round.”

On Thursday, the White House statement said its new plan would save the average community-college student $3,800 annually and benefit 9 million if fully realized.

TIME

Morning Must Reads: January 9

Capitol
The early morning sun rises behind the US Capitol Building in Washington, DC. Mark Wilson—Getty Images

Paris Terror Suspects Cornered

The prime suspects in Wednesday’s attack at the offices of satirical newspaper Charlie Hebdo fired shots at French police as the massive dragnet closed on them in a factory northeast of Paris, close to Charles de Gaulle Airport, with at least one hostage. They have told negotiators they want to die as martyrs

See If You’re Likely to Get the Flu

It’s not enough to know if your state is a flu hot zone. Now you can find out if the street you live on is teeming with flu cases, with these apps and websites

Obama’s Community College Plan

The President announced a proposal Thursday to provide two years of free community college tuition to students who maintain good grades

Game of Thrones Returns April 12

HBO announced Thursday that the fifth season of Game of Thrones will premiere on Sunday, April 12 at 9 p.m. E.T. Veep and Silicon Valley will both return that day as well, providing some much-needed comic relief after the bloody show

Signals Detected From AirAsia Black Boxes

Indonesia says it has detected signals from the black-box recorders of downed AirAsia Flight 8501 and is racing to recover them. “A ship detected the pings. The divers are trying to reach it,” S.B. Supriyadi, search-operations director, told media

Apple App Store Has Its Biggest Day Ever

Apple revealed that over the first week of January, customers spent nearly $500 million on iOS apps, a new record for the company. Apple said app sales rose 50 percent year-over-year and the company paid out $10 billion to developers in 2014

Keystone Pipeline Is Overrated by Both Sides

For the past several years, Republicans and Democrats have used the Keystone XL pipeline to prove their economic or environmental bona fides. The debate burns so brightly that it distracts from more illuminating subjects, like how much it really matters

Angelina Jolie Meets Pope Francis

Angelina Jolie, who was in Rome this week for a screening of her film Unbroken, met privately with Pope Francis at the Vatican on Thursday. The actress met other high-profile figures last year, including Queen Elizabeth, who named her an honorary dame

Ohio Switches Up Lethal-Injection Drugs

Ohio announced on Thursday it would drop a controversial two-drug combination used last year in the prolonged execution of Dennis McGuire. The state said it will revert back to a previously used drug, but it’s unclear how the state will obtain it

Ka-Boom! 2 Black Holes Get Ready to Collide

For cosmic drama, nothing should beat a supermassive black hole. It turns out that something does beat a giant black hole: two giant black holes, especially ones circling each other like wary Sumo wrestlers getting ready to grapple

NFL Didn’t See Ray Rice Tape Before Its Release

An investigation led by former FBI Director Robert S. Mueller III found no evidence that the NFL received the video of Baltimore Ravens star Ray Rice striking his then fiancée in a casino elevator before it was released in September

Andrae Crouch, Legendary Gospel Figure, Dies at 72

Andrae Crouch, a legendary gospel performer, songwriter and choir director, has died. Crouch died on Thursday at Northridge Hospital Medical Center, where he had been admitted on Saturday after suffering a heart attack

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