WASHINGTON — President Barack Obama last week touted new ways to help students pay for college, but he also proposed stripping away a popular benefit: a significant tax advantage of college savings plans used by millions of American families.
The benefit allows families to withdraw money tax-free from savings plans that have become a primary way for parents to save to send their children to college.
The plans, known as 529 plans, are considered a critical tool for Americans as the cost of tuition rises and outstanding student debt stands at more than $1 trillion.
The administration has tried to frame the elimination of the tax break as a way to redirect more money to middle-class families, saying that 70 percent of account balances are held by households making more than $200,000 a year.
But conservative critics quickly pounced on Obama’s plan, saying that it is deaf to the needs of ordinary Americans who are looking for any help they can get saving money for college.
“People don’t care that a wealthy person might also own a 529 plan. People care that they own a 529 plan, and that Obama is seeking to tax it out of practical existence,” Ryan Ellis, tax policy director for the conservative think tank Americans for Tax Reform, wrote in Forbes last week.
Conservatives warn that ending a key benefit of 529 plans would discourage families from saving and drive them to take on more debt to pay for college. They say the administration distorts the fact that a growing number of Americans earning less than six figures are investing in 529 plans.
“Why won’t Pres. Obama just admit his tax hike on college savings will hit the middle class?” tweeted House Speaker John Boehner.
Even if the proposal goes nowhere, which is likely in a Republican-controlled Congress, it could shape future higher education policy. That’s alarming to people outside the Beltway.
“This would eliminate all new investment in 529 plans,” said Mark Kantrowitz, publisher of , a financial aid website. He noted that Obama’s proposal would treat the earnings on 529 plans as student income, which would hurt a child’s chances of receiving financial aid.
“When you take into account not just the impact on taxes, but also the impact on financial aid, it wipes out all of the earnings,” Kantrowitz said. “You’d be better off in a way just putting the money in a mattress.”
The advantage to 529 plans, named for a section of the tax code, is that families can invest through these accounts without the earnings and withdrawals being taxed as long as the funds are used to pay for college expenses. But it wasn’t always this way.
Before the Bush tax cuts of 2001, any money withdrawn from a 529 plan was treated as ordinary income subject to taxes — a rule that Obama would like to revisit.
Very few people used the plans in those days, but that started to change once the tax cuts took effect. Assets in 529 plans have risen from $19.4 billion at the end of 2001 to $245 billion in 2014, according to the Investment Company Institute.
Affluent families have disproportionately benefited from the changes in the law. A report from the Government Accountability Office found that nearly half of families with 529 plans made more than $150,000 a year and had median assets of $413,000 — 25 times higher than the assets for families without the plans.
“It’s kind of just a cash giveaway to upper-income folks,” said Mark Huelsman, a senior policy analyst at liberal think tank Demos.
The College Savings Foundation, a nonprofit that advocates for 529s, said the 2012 GAO study is outdated and does not reflect the reality of who invests in the plan. The organization estimates that 70 percent of account holders earn less than $150,000 based on a 2014 survey conducted by Strategic Insight, a mutual fund research firm.
