I heard the other day that president Barack Obama proposed start taxing earnings on 529 plans. I always thought that tax-free earnings were the only major advantage of 529 plans (other than the benefits at the state level depending on your state). Wouldn't that make 529 plans practically useless? Am I missing some other big benefit I'm not aware of?


There was so much opposition by both parties that the proposal is dead. But yeah, the major benefit was going to get taxed, although not necessarily at the same brackets or rates. Year-to-year growth would still have been tax-deferred, so still a benefit.

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    Also, it was unclear if they would just end the benefits on future contributions or try to change how existing plans work. The problem, and the Obama administration has a good point, is that the primary beneficiaries of 529 plans are very wealthy people who can afford the cost of college anyway. – ssaltman Feb 7 '15 at 4:25
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    @ssaltman Let's take a poll using votes; for everyone who's wealthy and agrees with ssaltman that the primary beneficiary to 529s are the wealthy, upvote his comment. If you disagree, upvote my comment. Most of the people I know with 529s make less than $90K a year, which isn't how I'd define wealthy (can't the wealthy just use trust funds, anyway?). – user541852587 Feb 7 '15 at 15:01

No, it is not the only advantage.

Contribution to the 529 plan is considered a gift to the beneficiary for gift tax purposes. However, you can contribute 5 times the maximum exemption amount at once and "spread" it over the next 5 years for the purpose of gift tax exemption.

See the instructions to form 709 for details.

That is very useful in estate planning, as it allows excluding large amounts (up to $70K per beneficiary) from the estate at once. With the current estate tax rates - these are thousands of dollars in savings.

That explains why the rich people, who technically can afford tuition without any 529 plan, end up using them so much.

But for "normal" people, for whom the estate tax essentially no longer applies, the tax shelter/deferral is the main benefit and as @Rocky has told you - that was scrapped, rightly so.

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