Bush budget would impact 529 plans
1) The federal tax exclusion for qualified withdrawals from 529 plans would be permanently extended beyond 2010 under the general proposal to make permanent the tax changes in the 2001 EGTRRA and 2003 JGTRRA tax acts.
2) Lifetime savings accounts (LSA) would come on board in 2007, allowing anyone to make after-tax contributions to these tax-free investment accounts. The account owner could withdraw LSA funds at any time for any purpose without tax or penalty. Annual contributions on behalf of any individual would be capped at $5,000. In addition, 529 accounts and Coverdell ESAs could be rolled over to LSAs, subject to limits. The ESA rollover limit is the account balance at December 31, 2005 plus 2006 contributions.The 529 rollover limit is the account balance at December 31, 2005, not to exceed an aggregate $50,000 per beneficiary, plus 2006 contributions up to an aggregate $5,000 per beneficiary. If contributions are made to both ESAs and 529 plans in 2006 for the same beneficiary, the rollover of these contributions to an LSA cannot exceed $5,000 on a combined basis. The budget proposes that states be permitted to offer LSAs within their 529 plans, but it is not clear why any state would want to do that.
3) Individual Development Accounts (IDA) would be created for low-income families with a tax credit going to IDA sponsors who make dollar-for-dollar matching contributions up to $500 per year per recipient. The investment earnings on the contributor's funds would be subject to normal taxation, but the match account would be tax-free. The match account could be used for specified purposes, including higher education expenses, or paid out after the recipient reaches age 61. There is no specific tie-in to 529 plans.
4) The "deemed gift" that now occurs when a 529 account beneficiary is changed to a lower-generation beneficiary would be eliminated. To prevent transfer-tax avoidance, a new 35 percent excise tax would be imposed on non-qualified distributions above $50,000 (on a cumulative basis) made to a beneficiary who is not the original account beneficiary. The excise tax would increase to 50 percent on cumulative non-qualified distributions in excess of $150,000. Non-qualified distributions to the 529 contributor would be exempt from the new excise tax, although the current 10 percent penalty on earnings would continue to apply. The 10 percent penalty would be increased to 20 percent for non-qualified distributions made to the contributor more than 20 years after creation of the account.
529 accounts in existence prior to the date of enactment would not be subject to these rules, but no further contributions could be made to these "grandfathered" accounts.
The link provided here is to the Treasury's Blue Book explanation of the revenue proposals contained in the Bush budget.