I don’t hear anyone “squabbling” here; I was just trying to explain how the changes might affect families of varying incomes. I think I can safely say that the change would not really affect anyone who has already put money into a 529 because the White House proposal is designed to only tax the gains on future contributions made to 529s. So someone like you, who has I assume, already put your money in, will not pay any capital gains on 529 money used for educational expenses, no matter what your income level is today. But, honestly, my guess is that your gains are a lot more modest than what you think they are, e.g., more like the middle class family that I posited rather than the Daddy Warbucks.
It’s also true that if you hit the 200,000 income level that you think you will, you won’t be eligible for the AOTC which phases out at 180,000 under the President’s plan (and less for singles, as others have pointed out). But certainly the income phase-out levels could be something that is negotiable for the White House and Congress if they ever got anywhere in drafting legislation for this. For other purposes, Obama and Congress have defined the wealthy at 250,000 per yr or even higher, so that might be an area of compromise. I think it’s premature to dismiss this proposal as either a betrayal or the middle class or a sop of the rich.
Well, another way to answer that question is, yes. When the govt figures out who gets tax breaks and who pays more or who gets financial aid or subsidized whatever it has nothing to do with the fact that 20 years ago you made much less since it’s figured on annual income. And, sometimes even assets are not a factor, so yeah. Some people will be surprised that learn that they go into the rich people category. That said, I agree this idea is pretty much dead on arrival.
@dadoftwingirls I also am not sure of the relevance of the fact that when you put the money in you were not “well off”. For better or worse that’s the way the tax system works. I mean, if back in 1980 you saw this little scrappy computer company and bought some shares because you happened to like their fruit logo, and you ate ramen noodles for a month to save the money for that, then 30 years later you have a quarter million dollars worth of Apple shares, I don’t think you get to claim that you should pay at your old grad student tax rate. It is what it is. I’ve said above that I happen to like this tax break in principle, but I like that @spayurpets has done some back-of-the-envelope calculations so this doesn’t become a knee jerk “don’t take my deduction away!” reaction.
Which states allow uncapped deductions on 529 contributions? The Daddy Warbucks example seems to be rife with assumptions that don’t actually work in the real world i.e. the one we all live in.
per the IRS you are only limited to $14k per individual (couples can give $28k) to avoid gift taxes, it’s not a provision of the 529:
Q. Are there contribution limits?
A. Yes. Contributions can not exceed the amount necessary to provide for the qualified education expenses of the beneficiary. If you contribute to a 529 plan, however, be aware that there may be gift tax consequences if your contributions, plus any other gifts, to a particular beneficiary exceed $14,000 during the year. For information on a special rule that applies to contributions to 529 plans, see the instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
In any year during which your 529 contributions for a particular beneficiary exceed $14,000, you may make an election on Form 709 to spread the contributions ratably over five years (20% per year) for gift-tax purposes. This permits frontloading of up to $70,000 per beneficiary (or $140,000 for a married couple) into a 529 plan without generating a taxable gift, assuming no other gifts to that beneficiary are made during the five calendar-year period
Picky picky. Okay, so let’s say Warbucks lives in New York, which is the 9% state income tax state I was thinking about, they have a $10,000 above the line limit on 529 contributions. Assuming Warbucks made the contributions in even increments over 20 years, say, he would only be able to deduct $200,000 of the $250,000 contributed from his state taxable income, so this would reduce this savings from $22,500 to $18,000 and overall from $70,300 to $65,800. But remember, this number ignores the state capital gains tax which I probably should have added in plus the effect on New York City tax if Warbucks lives in NYC, which is substantial. If you add those back in, you might be talking about well over $75,000 in savings.
And, seriously, in coming up with Daddy Warbucks I was trying to think of an example of someone who can benefit a lot from a well-designed tax strategy with 529 accounts, but this is really only scratching the surface of what some wealthy people do with 529s. You can overfund the 529 and let it sit there, growing to millions; you can create dozens of them, limited only by the number of beneficiaries you can think of (My parents, for example, created accounts for my children as beneficiaries, with the intention of changing the beneficiary to my siblings’ unborn children); you can pay college tuition by funnelling your tuition payments through the 529 (I know parents who do this to get the state tax deduction; they pay the $25,000 into the 529 on Monday and on Tuesday the $25,000 is wired out to the university). There are reasons that people like Mitt Romney have as much as $100 million tucked away in an IRA in the Cayman Islands. The ultra wealthy have tax advisors who know how to maneuver these waters and save millions of dollars in taxes from a simple thing like a 529.
The Mitt Romney example worked because of the enormous leverage he used in taking positions in companies (distressed, start ups, companies in bankruptcy) and putting that stock into an IRA. Lots of other tax schemes work because of Carried Interest regulations . If you are suggesting that someone can achieve the same results in a 529 I’d love to see your example. 529 contributions are capped in most states (but please let me know if you find one where they are not), and unlike other methods of postponing tax payments, have a very limited legal use of the funds when they are liquidated.
I’m not being picky. I think you’re arguing a straw man’s position. How many 529’s have grown to millions of dollars?
You seem to be suggesting that lots of wealthy people are using 529’s as an efficient generation skipping tax dodge. Ok- I accept your premise. But are you also suggesting that they are too stupid to use other, more efficient generation skipping tax dodges (see Jackie Onassis as exhibit A) but ARE smart enough to plough millions of dollars through their grandchildren’s 529’s??? And that they are smart enough to hide liquid assets into their unborn great grandchildren’s accounts without ever wondering if the regulations are going to change, leaving them with an enormous tax bill either during their lifetime or for their estate?
I just haven’t met a lot of really rich but somewhat dumb folks. that’s why you think I’m picky.
I wasn’t saying that you could end up with $100 million in a 529 account, but I was using that as an example of creative tax planning that the ultra wealthy employ. I actually think the Warbucks example is pretty reasonable and is not a strawman at all.
And I could easily see a person having tens of millions in 529 accounts. Mitt Romney has 23 grandchildren. Planning ahead, he and Ann can give $28,000 per grandchild over the next 20 years and that would add up to $12,880,000 (and that $28,000 is also indexed for inflation, so it’s going to go up). Over that time, the investment could easily double. So he has $25 million in 529 accounts just of his own money for his grandchildren. And as I have pointed out the $14k/$28k per year gift limit is pretty easy to get around. You can have multiple family members contributing into those accounts; the parents, both sets of grandparents, aunts, uncles etc. Yes, there’s a theoretical IRS limit to how much is enough for education expenses of one person, but is it $500,000, $1 million? A four year private college education costs $300,000 all-in today; throw in two graduate degrees of $250,000 each, and I could easily see a parent argue that they should not be prevented from putting more than $1 million into a 529 account. And I again add the note, that you can create an infinite number of 529 accounts and fund them because there is no limit on a person making tax free gifts. My friends have a 529 for their housekeeper’s children as well as their own.
At the back end, if the money is not spent, I’m not sure what happens, but as I recall you can spend it on things other than education if you reach the age of retirement. Or you can change the beneficiary to another younger person and start it all over again. There are really endless possibilities. I think that’s one of the reasons why the White House wants to go after these; they can see the data that 529s are being abused as a tax shelter, and they want the benefits to go toward real college expenses.
Someone setting up a 529 for their housekeeper’s kid is actually setting up funds to be used for the intended purpose- a college education. Is it your contention that they would be using the funds for a different purpose (i.e. paying for trips to Cancun?) If so- that’s fraud. And I’m not impressed. People commit fraud every day and they don’t need the tax shelter of a 529 to do so.
I’m not quite understanding your example of the housekeeper’s kid. The kid’s social security number was obtained without the parent’s knowledge? How is this a tax dodge- the kid turns 18, goes to college, liquidates the fund as he/she pays tuition… and your generous friend benefits how exactly from this? Somehow your friend knows that 10 years from now he’ll have the exact same housekeeper who can somehow rebate the excess 529 funds back to him??? How is this back-end of over funding working for a housekeeper?
Sorry I’m not keeping up here. And yes, I think it’s a strawman if you are coming up with all sorts of nice examples of someone abusing the 529’s but with no actual examples of how someone circumvented the regulations on how the cash can be spent once it’s liquidated.
To clarify, this is not true. States limit the deductibility of 529 contributions at certain dollar levels, varies from $6000 to $16,000, per year, i.e. there’s a limit to how much of your contributions can be deducted from your state taxes. A handful of states are limitless. There is no actual cap on how much you can put into a 529 in any single year so far as know. Of course, this does have tax consequences at certain levels, e.g., state deductiblity, gift taxes. So you could put $100,000 into a child’s 529 account, but then you would have to deal with gift tax and you’re squandering the tax benefit by doing this. But some people will want to do this because the capital gains after letting that money grow is tax free. And as I said before, the IRS has said that there is a theorectical limit on the amount of money in a 529 account to cover reasonable educational expense but there is no actual regulation on how much this is.
Re the housekeeper example, I wasn’t saying this was an abuse. It was legitimate desire of my friends to pay for their housekeeper’s children’s college tuition. But you have to see that that is a way to shelter income from the IRS, don’t you? If they didn’t do it this way, they would have had to pay taxes on that money over time as it produces income. The whole point of these tax strategies to put off the day that you pay taxes on money and let it grow tax free. Some of it is legitimate but some of it is not.
TBH, I’m not sure what we’re arguing about either. I showed how the AOTC may be better for the middle class than a 529, which is all that really meant to say. For higher income folks like myself, probably not.
Dumping 100K into a 529 in one single year-- and filing the gift tax forms, etc. just to get the benefit of it growing tax free… hmm. And this wealthy person wouldn’t rather take the same 100K and put it in a donor advised fund, letting it grow tax free, and to dole out the annual donations to the alma mater, cancer research fund, etc?
Yes- the point of the tax strategies is to put off the day you pay taxes on the money. But only if you can “unlock” the dough for what you want to do with it when you or your heirs want it. You can’t take a cruise with it, you can’t buy a house with it. You can pay tuition with it, and therefore overfunding a 529 seems to me to be a teeny tiny public policy problem.
In actual fact, this is rather a good idea and as some commentators have noted, it does look to ‘re-distribute’ the tax advantages to MORE people, not necessarily those wealthier families who can fully contribute to a 529 account. Many tax advisors see this as a better way to help, it would help many many more families afford college, but likely as not those families aren’t using CC.
The Obamas sure loved their 529s, and, thanks to their new taxpayer-funded income when they arrived at the White House in 2008, they were able to front-load their daughters’ 529 plans with $120,000 each. In 2008, their daughters’ accounts were sitting pretty with a total of $240,000. Who knows what those accounts are worth now. And I cannot find one online source that describes how the Obamas, feeling guilty about not really needing the tax benefits of those 529 accounts, chose to go ahead and pay all the taxes they could. Unless he’s announcing that he and his wife are shutting down their 529s, and paying the taxes, then I have absolutely no interest in what he has to say.
I think the IRS simply says that the contributions on behalf of any one beneficiary cannot be more than the amount necessary to provide for the QEE of the beneficiary; determining what that amount is falls to each plan administrator. See IRS pub. 970, pg. 57 (“How Much Can You Contribute”):
For example, the plan that I am most familiar with caps contributions for an individual beneficiary across all 529 accounts at $235,000:
High Maximum Account Contribution Level of $235,000
You can contribute as much as $235,000 per beneficiary as long as the total balance of all accounts for that beneficiary does not exceed $235,000, including contributions to the Michigan Education Trust (MET) and the Michigan 529 Advisor Plan. Accounts that have reached the maximum account balance limit may continue to accrue earnings but no additional contributions may be made.
There’s nothing that I’ve ever heard of in the 529 rules about retirement age. The account owner can always spend 529 funds on things other than education, no matter what age, as long as tax is paid on the earnings, as well as the additional 10% penalty (which is waived in some cases).
According to articles about this proposal, the average balance in all 529 plans is around $20,000. If Mitt Romney or Daddy Warbucks is sitting on a $million+ 529, then there’s some large number of people with about enough balance in their 529 account to buy a semester’s worth of school supplies. That does not seem likely. I do not think that 529s are being abused as tax shelters for the super-rich. Fortunately, as others have said, this latest redistributionist Obamagrab is DOA in Congress.
Okay, so let’s say Warbucks lives in New York, which is the 9% state income tax state I was thinking about, they have a $10,000 above the line limit on 529 contributions. Assuming Warbucks made the contributions in even increments over 20 years, say, he would only be able to deduct $200,000 of the $250,000 contributed from his state taxable income, so this would reduce this savings from $22,500 to $18,000 and overall from $70,300 to $65,800. But remember, this number ignores the state capital gains tax which I probably should have added in plus the effect on New York City tax if Warbucks lives in NYC, which is substantial. If you add those back in, you might be talking about well over $75,000 in savings.