One More Reason 529s are a Dumb Idea

I confess to being a happy user of Section 529 Education Savings Accounts, although I confess also to thinking that, as a public policy matter, they are a pretty dumb idea. So with the IRA idea in general: a scheme where the taxpayer, at discretion, can tuck away money now and decide when he feels like paying a tax on it. Jeeze, Louise, how can a government do any responsible planning in a world like that? Some of the dumbness is extracted if we have limitations on how and when you draw it out: mandatory draw on IRAs for example. But 529s seem to me to be more flexible than most: flexible in terms of how or when you draw and indeed, in terms of how you use the money. Now, Joe Hurley points out one further aspect of the silliness--gift taxation. Hurley starts from the principle that you can give away up to $13,000 per person per year free of gift tax. He says:

[W]hy doesn't every well-off individual fully utilize his or her annual [gift] exclusions? No doubt it's because most people don't like the idea of giving away their hard-earned dollars. To be eligible for the gift-tax annual exclusion, the gift must be irrevocable, and it must be made without any strings attached (except for what your attorney may be able to craft through a trust or family partnership). What's yours now no longer belongs to you, and that can be a tough pill to swallow.

Unless, of course, we're talking about a 529 plan.

With a 529, you have the right to change the beneficiary to another family member, direct the use of distributions, and even ask for the money back at any time (subject to tax and 10 percent penalty on the earnings). Yet your contributions to the 529 plan are treated as gifts from you to the account beneficiary, and those gifts qualify for the $13,000 annual exclusion. It's quite extraordinary.

"Quite extraordinary" indeed. The history of the gift tax is the history of devices designed to let you give something away (for tax purposes) without, you know, really giving it away. The 529 rule seems to come as close as you can get to abolishing that distinction. Yep, you have that 10 percent penalty, but it is on earnings only, not principle. Not much of a constraint against later second thoughts.

Update: Earlier I said "Roth IRA." Actually, Roth-type IRAs are far less disruptive than ordinary old fashioned IRAs. But they're still a lousy way to do public business.