Maybe the best thing about the new tax bill is that long before it really kicks in in the worst way – for example, reducing the top estate-tax bracket from 55% to zero in 2011 – it can be undone. Eventually, the squeeze from the lost revenues – a mere $1.35 trillion over the next 11 years as it phases in (a trifle!), but perhaps $4 trillion over the following 11 years once it is fully phased in – eventually this may cut so deep into the things people want government to do that a lot of the cut for the wealthiest 1% or 2% will be uncut.
This is more or less what Clinton did in 1993 to get the budget on the road to balance and the bond market on the road to lower rates and the economy on the road to its best eight years ever.
Here’s how cartoonist Tony Auth envisioned the situation a couple of days ago.
That said, some aspects of the bill are swell, and will send the right signals to average taxpayers, encouraging them to save for college and retirement. That’s good for them and good for the country, because our savings rate is too low.
- Education IRAs no longer stink. In exchange for allowing a measly $500 per year non-deductible contribution to a plan that distributed its earnings tax-free for college, the taxpayer lost the more valuable HOPE and Lifetime Learning Credits and was prohibited from contributing to other tax-deferred education plans in the same year they used the education IRA.
- No more. Starting next year, the contribution limit jumps to $2,000 and all of the other restrictions have been eliminated. A person who contributes to an education IRA will be able to contribute to other tax-deferred education plans in the same year. And the taxpayer will be able to claim education tax credits even in a year that money is withdrawn from an education IRA. (Except that the tax credit will only be allowed for expenditures other than from the education IRA itself – which seems reasonable, since the money from the education IRA was distributed tax-free.) From 2002 on, unless your income is too high to qualify, the education IRA may well be the place for the first $2,000 you save each year for college.
- Qualified State Tuition Programs can now be wonderful. These plans, commonly known as “529 plans” after the section of the Internal Revenue Code that permitted their creation, have been established in nearly every state to allow tax-deferred savings for college. But it just got better. Starting in 2002, distributions from a 529 plan for college should be entirely free of federal income taxes (and the states will, by and large, probably conform for state taxes). Those of you who have been saving for college in your own name or using Uniform Tranfer to Minors Act accounts need to reconsider. A tax rate of 0% is hard to beat. And there are NO income limits to use 529 plans, and virtually no contribution limits. (But check with a tax pro before you add more than $10,000 in a single calendar year, because you’ll have to do it in a special way. And, actually, check with someone before you make any drastic move induced by today’s column, because ink is still drying on the law and I can’t be certain I haven’t misunderstood or overlooked something.)
- One of the worst features of the 529 plans was that, once enrolled, you couldn’t switch. No more. You’ll be allowed to roll your 529 from one state to another once in every 12-month period. So if you fell in love with the Utah plan last year for its 0.31% expense ratio on an S&P 500 index fund, but now you’re eyeing Missouri’s plan, with only a 0.65% expense ratio for a fund that’s split 80% U.S. and 20% International – thinking the extra diversification is worth the increased expenses – you should be able to switch in 2002 and subsequent years, just so long as you wait at least 12 months each time.
- This competition is going to force the states to make their offerings ever better, as they no longer have captive investors. And not only the states – the new law permits private colleges and universities to start offering 529 plans, too. This is likely to become THE way to save for college. I’ve mentioned Joe Hurley’s savingforcollege.com several times here. Check it out for the latest on what the states are offering.
- Tuition may be tax deductible. If your income isn’t too high, you’ll be allowed to claim tax deductions for tuition payments (but not for money paid out of an education IRA or 529 plan). The maximum deduction will be $3,000 in 2002, and rise later on. This may or may not be a good idea, since you cannot claim the HOPE or Lifetime Learning credits if you claim the deduction. Generally, a HOPE credit (which is $1,500) is better than a $3,000 tax deduction. (If you’re in the new 27% tax bracket, the deduction is worth only $810 – 27% of $3,000.) The Lifetime Learning Credit is a little trickier: it is only 20%, so a credit on $3,000 would only be $600 – you’d prefer the deduction. But a credit can be claimed on up to $5,000 of tuition – making the credit, in this example, more desirable at $1,000 than the tax deduction of $810.
- Student loan interest deductions will now apply for the life of the loan. They used to grant deductions for the first 60 months of the repayment period only, but that limit has been removed. Also, the income levels at which the deduction is allowed have increased a bit. Both good news for those of you who had to finance college costs in the past. But that doesn’t mean you shouldn’t still try to lower the rate on the loans: check out www.loanconsolidation.ed.gov to see if you can consolidate at a better rate.
So . . . beginning with 2002, take another look at education IRAs (for the first $2,000 you save each year) and 529 plans (for anything you can save above that). If you need more information about the new law, “Ask Less” – see the tastefully blinking asterisk in the upper left corner of this page? About an inch below my picture, which, let’s admit it, shows me precisely as I was in 1957? (I now, as you know from a recent column, weigh 400 pounds. And instead of a blue tint, I appear largely green.) Click on Ask Less and my estimable friend Less Antman, who has explained the new law to me in baby syllables, will be glad to try to handle your specific stumpers on this or any other financial question. All part of your subscription fee.
Coming Soon: The New Improved Rules on Retirement Plans
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The people who sustain the worst losses are usually the ones who overreach. And it's not necessary: steady, moderate gains will get you where you want to go.~John Train
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