529 COLLEGE SAVINGS PLAN



House Bill 5653 as enrolled

Public Act 162 of 2000

Sponsor: Rep. Gary Woronchak


House Bill 5654 as enrolled

Public Act 163 of 2000

Sponsor: Rep. Scott Shackleton


House Committee: Tax Policy

Senate Committee: Finance


Senate Bill 599 as enrolled

Public Act 161 of 2000

Sponsor: Sen. Mike Rogers

Senate Committee: Finance

House Committee: Tax Policy


Second Analysis (7-13-00)



THE APPARENT PROBLEM:


Federal tax law allows individual states to establish state-sponsored college savings plan programs under which people can make contributions to special tax-deferred savings accounts. Earnings accumulate in such an account tax free and are then distributed to a beneficiary to pay expenses associated with postsecondary education, such as tuition and fees, room and board, books, etc. Earnings on the accounts are taxable at the federal level when withdrawn for higher education expenses but at the student's (presumably lower) tax rate. When creating these special accounts, some states exempt contributions, earnings, and withdrawals from state income taxes. The plans are sometimes referred to as 529 plans because they are authorized in Section 529 of the federal Internal Revenue Code. (The same section also authorizes states to establish tuition prepayment plans, like Michigan's MET program.)


Reportedly, about 32 states have set up college savings plans as a means of helping families deal with the high costs of obtaining postsecondary education, which is increasingly seen as a necessity. The recent report issued by the Michigan Commission of Financing Postsecondary Education, chaired by Lt. Governor Dick Posthumus, recommended that Michigan create such a program, in part as a way of reducing student debt burdens. Legislation has been introduced to accomplish that goal.


THE CONTENT OF THE BILLS:


Senate Bill 599 would create the Michigan Education Savings Program Act and establish the new savings program within the Department of Treasury. The bill would allow individuals to contribute money to education savings accounts, with the proceeds to be used to pay qualified higher education expenses, including tuition, fees, books, supplies, and required equipment, as well as room and board in some cases. A person could establish one or more education savings accounts for one or more designated beneficiaries. The total contributions that could be made to all of the accounts naming any one individual as beneficiary would be $125,000. The required minimum initial deposit and required minimum contributions in the first year of the program could not be greater than $25 for a cash contribution or $15 per pay period for a payroll deduction plan. Money in the accounts would be invested by a program manager selected by the Department of Treasury, who could charge a fee of up to one-and-one-half percent of the average daily net assets of the program. Education savings accounts could be established beginning October 1, 2000. (Further details of Senate Bill 599 are provided later in the analysis.)


House Bill 5653 would amend the Income Tax Act (MCL 206.30) to allow a taxpayer to deduct contributions made to an education savings account, not to exceed $5,000 for a single return, or $10,000 for a joint return, per tax year. (This would apply to contributions made after October 1, 2000.) A deduction, however, would not be allowed under this provision for contributions to an education savings account in the tax year in which the initial withdrawal was made from that account or any subsequent year. The bill also contains a provision not directly related to education savings accounts that would allow a taxpayer a deduction for withdrawals from individual retirement accounts used to pay qualified higher education expenses.


House Bill 5654 would amend the Income Tax Act (206.30f) to allow a deduction for interest earned on contributions to an education savings account, and also to allow a deduction for a qualified withdrawal from such an account used to pay the qualified higher education expenses of the designated beneficiary of the account. The bill also would require that money withdrawn from an account and interest earned on that amount be added to taxable income if the withdrawal was not a qualified withdrawal.


The term "qualified withdrawal" is defined in Senate Bill 599 and would apply, generally speaking, to a withdrawal to pay for the qualified higher education expenses of a designated beneficiary at an eligible educational institution. The term would also apply to some other cases, such as the death or disability of the beneficiary, the awarding of a scholarship to cover some or all of education expenses, a transfer of funds due to a change in beneficiary, or a transfer of funds due to the termination of a program manager's contract. An account owner could withdraw all or part of the balance of an account on 60 days' notice or a shorter period as authorized by a savings program agreement. A distribution that was not a qualified withdrawal would also be subject to a penalty of 10 percent of the distribution, to be paid to the state's General Fund (although the penalty could be increased or decreased by the state treasurer and the program manager, based on federal requirements). The term "eligible educational institution" would refer to a college, university, community college, or junior college under the state constitution or institutions eligible to participate in student financial aid programs under the federal Higher Education Act (which includes technical and vocational schools).


The bills apply to tax years beginning after December 31, 1999. House Bills 5653 and 5654 are tie-barred to the Senate Bill 599, which in turn is tie-barred to the two House bills.


Among the provisions of Senate Bill 599 are the following:


Program Administration


Savings Accounts


FISCAL IMPLICATIONS:


The House Fiscal Agency reports that the combined impact of the bills would be to reduce income tax revenue by about $5 million annually. (HFA fiscal note dated 4-18-00)


ARGUMENTS:


For:

The Michigan Education Savings Program would provide Michigan families with a new tool to use in paying for postsecondary education, whether at a four-year school, a community college, or a training school. The program is designed to meet the federal IRS requirements for education savings plans and allow individuals to contribute to tax-deferred savings accounts. Post-secondary education is commonly viewed as a necessity in today's economy, yet the costs of higher education strain family budgets and sometimes make schooling impossible. Some students acquire significant debt, which can distort their career choices. Families who begin early to use education savings plans can, by taking advantage of compounding, turn even small regular contributions into substantial savings. Education savings accounts allow grandparents, parents, and other relatives (or anyone else) to contribute to an account on behalf of a prospective student, and gain state tax advantages. A person can even create an account with himself or herself as the beneficiary. The program is open to postsecondary students of all ages and situations and participants can be from all income levels. Students can attend schools in the state or outside of the state, public schools or private schools. And money in the account can cover a wide range of educational expenses, including room and board for full-time students, not just tuition. Moreover, the use of these accounts does not prevent a taxpayer from making use of other federal education tax programs, such as the Hope credit and lifetime learning credit (as some existing savings programs do).


The accounts will be administered by a program manager selected by the state treasurer, so that account owners and beneficiaries can rely on professional money managers, which is preferable to the savings and investment strategies individuals without knowledge of investing might engage in on their own. Contributions grow tax deferred for federal tax purposes, with taxes due on earnings only when withdrawn by the student. Contributions, earnings, and withdrawals will be deductible for purposes of the state income tax.

Response:

Some people suggest that without a limit on the income of people who can contribute to an education savings account, the bills favor upper income individuals, who could simply move other savings into the new account to get tax savings. The contribution cap of $125,000 similarly favors the affluent. The typical complaint against a program of this kind is that it rewards those who would have provided their children to higher education rather than those who need the additional incentive or encouragement. Some people have objected to the administrative fee being applied to the accounts opened by low and moderate-income contributors. More needs to be done in general to encourage lower income people to participate.





Analyst: C. Couch



This analysis was prepared by nonpartisan House staff for use by House members in their deliberations, and does not constitute an official statement of legislative intent.