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529 Landmine

by Anthony J. Ogorek Ed.D., CFP™

With just two years remaining on his term, President Obama is beginning to pull out all of the stops to increase spending while the getting is good.  According to the non partisan Congressional Budget Office, the Federal budget deficit will continue to shrink for the next couple of years before it begins its inexorable rise beginning in 2017.  At that time, entitlement programs for the baby boomers will begin to consume an increasing percentage of the Federal budget.

Just this week, the president proposed spending totaling $74 billion above the sequestration budget caps imposed by Congress, in addition to the alleviation of tax-free withdrawals from 529 plans.  The Administration quickly withdrew the proposal to assess capital gains taxes on the popular savings vehicles for college expenses.  529 plans, creatures of the federal tax code, are administered by individual states.

What was concerning about the 529 trial balloon is that proposals such as this undermine the confidence of the public in terms of buying into long range wealth creation strategies being promoted in the tax code.  Roth IRA’s are popular vehicles, analogous to 529 plans, in that an investor receives no current tax deduction in return for tax deferral while assets are in the account, and tax-free distributions, assuming that certain conditions are met.  If a president can propose the taxation of previously tax-free vehicles, without any grandfathering provisions, it is fair to assume that as annual budget deficits are expected to double over the next 10 years to $1 trillion per year, tax-free vehicles such as 529 plans and Roth IRA’s will be in the crosshairs for a certain strata of taxpayers.

The record low interest rates that The Fed has engineered since 2008 have allowed Congress to get a nearly free pass on the ever increasing federal debt.  At some point in the future, rates will begin to rise, and with it the interest we must pay on our debts.  This will exacerbate the painful choices that low rates have allowed us to avoid.