Obama Wants to Tax College Savings Accounts (and It’s a Great Idea)

Saving for Harvard might get a little tougher.  

Photo by Joe Raedle/Getty Images

President Obama’s State of the Union tax plan is all about taking from the rich and giving to pretty much everybody else. But conservatives have stumbled on a piece of it they think the middle class will hate: The White House, you see, wants to increase taxes on 529 college-savings accounts. The anti-IRS fundamentalists at Americans for Tax Reform are crowing: “This middle class income tax increase is a clear violation of President Obama’s ‘firm pledge’ against ‘any form of tax increase’ on any family making less than $250,000.”

Strictly speaking, they are correct. Obama’s proposal would hit some families that earn below the quarter-million-dollar mark. It’s also still a great idea. Unless, that is, you’re really determined to subsidize college tuition for families with six-figure incomes so they can send their kids to Amherst or Brown. 

First a little background: 529 college savings plans are tax-deferred accounts in which parents can stow away up to $14,000 per year for their child’s education (any more, and they have to worry about the gift tax). Unlike a 401(k) retirement plan, families can only save post-tax dollars in them. But once the money is in the account, it can be invested in stock or bond funds, and grow tax-free. Then, when Mom and Dad withdraw their cash to pay for Junior’s school, the gains aren’t taxed.

Obama wants to change that slightly. Under his proposal, investments could still grow tax-free. But when families retrieve their money, the gains will be taxed as ordinary income. As the Wall Street Journal notes, this is how 529 plans worked in the 1990s, until the Bush tax cuts made them even more generous.

So, yes, Obama wants to tax college savers. But, by and large, they’re wealthy college savers. When the Government Accountability Office looked at 529 plans and their less popular cousins, Coverdell accounts, it found that 47 percent of families that had them earned more than $150,000 per year. (Depending on who’s measuring, that puts them in at least the top 10 percent of U.S. households.) By comparison, it noted, the median income of families with a student in college is $47,747.

I don’t know about you, but I generally don’t think that our higher education policy should be geared toward helping families that earned $150,000 or more send their kid to the most expensive possible school. Meanwhile, the White House says that revenue brought in from taxing gains in 529 plans would go toward expanding other higher education tax breaks, such as the American Opportunity Tax Credit, which is available to families earning up to $180,000. So it seems like the middle class makes out just fine in this deal.

See more of Slate’s State of the Union coverage.