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Closing-out a 529
Old 08-18-2016, 05:42 PM   #1
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Closing-out a 529

DD2 has started her senior year, and there's still going to be money in the 529 account. I think I've decided to close the account, pulling out the remainder so I can pay-off her loans, as I promised (the only reason she got the loans was because they were interest-free).

All along I've been pulling out the difference between the published school budget and the grants and scholarships. This money comes out completely tax-free. So say the budget is 25K and there's 15K in grants and scholarships. 10K comes out tax-free.

So far, I have not pulled out any money where tax was due on the gains, but this year, I think I'm going in that direction. So for the remaining $15K, tax will be due on the gains. But I will have it come-out in DD2's name, so it won't alter my O-MAGI. She will show that as her only income in 2016, so pretty painless.

The last kind of money is that which is higher than the school budget. So let's say there is $30K in the 529 account, 10K comes out tax-free, 15K comes out paying tax on the gains, and the last 5K you not only pay tax on the gains, but also a 10% penalty since it's more than what the price of school was. I'll need to read-up, but I don't think the earlier years' school budget money "builds-up", so a $500 penalty might be in the cards (on my daughter's taxes).

I know it would be trivial to leave the account open and just write a grandchild's name in as the beneficiary, but I would like to have plenty to pay-off DD2's student loans and purchase her a car.

Anyway, although I'm usually the one answering 529 questions here, but I thought I'd throw this plan up here to see if anyone had experience with this stuff, or if there's a hidden wrench in the works.
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Old 08-18-2016, 06:36 PM   #2
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What if she decides to go to grad school? That option is now on the table for DS. Few positions have shown up in 3 states he's looking at and he is working out how to work in the meantime. He is much more likely to land a teaching position with a master's degree and they get a higher pay scale automatically.

You may want to hold onto the account a bit longer.


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Old 08-18-2016, 06:38 PM   #3
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I'm not sure about paying for her car, but why would any amount used to pay student loans down be taxable? I thought 529 money could be spent on anything education-related. I didn't think yearly withdrawals were capped at the cost of the school.

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Old 08-19-2016, 09:13 AM   #4
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First, I have to correct this from the first post of the thread:
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Originally Posted by sengsational View Post
So for the remaining $15K, tax will be due on the gains. But I will have it come-out in DD2's name, so it won't alter my O-MAGI. She will show that as her only income in 2016, so pretty painless.
Tax will NOT be due on the gains for that chunk of money! In my example, the entire of the school's published budget of $25K would come out tax-free, since what ever school costs comes out tax-free, of course, otherwise why bother with a 529. I think the way to look at that example is first say "what did I pay for" (either with cash or loans). In this example, that would be $5K out of pocket, $5K in loans. Then add "discounts" (aka scholarships and grants). In this example, that would be $15K. So you can take out as much as 5+5+15=25K tax-free. Although that says nothing about the published school budget, the $5K out of pocket is the EFC (expected family contribution), which is calculated using the budget (budget - discounts - loans = EFC).

I really wish I could have written this post before my first kid went away to school...I would have spent so many fewer hours staring at spreadsheets and fretting over the contents of 1099-Q and 1098-T forms! Not to mention trying to keep actual spending documentation for some kid who thinks I'm nuts for trying to collect actual spending documentation. I hope the google machine leads unsuspecting parents to this post so they can have an easier time of it than I had.

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Originally Posted by EastWest Gal View Post
What if she decides to go to grad school? That option is now on the table for DS. Few positions have shown up in 3 states he's looking at and he is working out how to work in the meantime. He is much more likely to land a teaching position with a master's degree and they get a higher pay scale automatically.
That's a good point. A good reason for leaving it there is that it's making a couple percent better than I'd get "on the outside". The question I've been pondering is "why not now?", and I think because the grad school question hasn't been completely ruled out, December is probably a better time-frame. Of course in or out of the 529, it could be used for grad school, just that the gains would get taxed, but at her low rate. Of course she could blow the wad of cash on something other than school then!

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Originally Posted by trapperjohn View Post
I'm not sure about paying for her car, but why would any amount used to pay student loans down be taxable? I thought 529 money could be spent on anything education-related. I didn't think yearly withdrawals were capped at the cost of the school.
This is a logical view, certainly. But we're talking about US tax law . From what I understand, student loans are not a qualified education expense. That's understandable because they let you pull-out, tax-free, the amount school costs; you "should" do that and just not take-out loans if there's still money in the 529. But I couldn't walk away from interest free loans, so didn't do it that way.

One thing I wish I knew at the beginning was how to execute the distributions from the 529. At first, I was paying the school directly out of the 529. But there were expenses that were qualified education expenses that didn't go to the school...lots of expenses, like room and board, books and supplies, health insurance, travel to and from. So I tried to keep track of the actual expenses, then remember to get a check cut to myself (or the student) for that amount. That was a real pain.

If I had to do it all over again, when they went-off in the fall, I'd pull out the entire school-year's budget in one transaction. Money would come out payable to the student. Stick it in an account where the student and I both had access, but with her as primary (this would only work with a trustworthy kid). The agreement would be that I'd be the one to initiate transfers to her spending account. Based on the EFC, I'd set-up a weekly transfer to her spending account. I've done this weekly transfer thing for most of the time my second student was in school, but didn't do the once a year pull from the 529 in the amount of the published school budget.

When it comes to using the actual expenses versus published school budget, I didn't read-up on it, but how far off could I be from the budget? Tuition/fees, Room & Board, Books and Supplies (including a computer & keeping it running) make up 90% of the budget, and I paid for that stuff, for sure. The principle is that whatever the "rack rate" is for those things and other qualified expenses is what comes out of the 529 tax-free.
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Old 08-19-2016, 02:11 PM   #5
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Quote:
Originally Posted by trapperjohn View Post
I'm not sure about paying for her car, but why would any amount used to pay student loans down be taxable? I thought 529 money could be spent on anything education-related. I didn't think yearly withdrawals were capped at the cost of the school.

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The IRS has specific criteria for qualified use of 529 monies. Cars, insurance not required by the educational insititution, payment on student loans, and transportation are items that do not qualify.
See IRS Pub 590 for details or good info on The Internet Guide to Funding College and Section 529 College Savings Plans. Savingforcollege.com
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Old 08-19-2016, 02:37 PM   #6
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Quote:
Originally Posted by sengsational View Post
First, I have to correct this from the first post of the thread: Tax will NOT be due on the gains for that chunk of money! In my example, the entire of the school's published budget of $25K would come out tax-free, since what ever school costs comes out tax-free, of course, otherwise why bother with a 529. I think the way to look at that example is first say "what did I pay for" (either with cash or loans). In this example, that would be $5K out of pocket, $5K in loans. Then add "discounts" (aka scholarships and grants). In this example, that would be $15K. So you can take out as much as 5+5+15=25K tax-free. Although that says nothing about the published school budget, the $5K out of pocket is the EFC (expected family contribution), which is calculated using the budget (budget - discounts - loans = EFC).

I really wish I could have written this post before my first kid went away to school...I would have spent so many fewer hours staring at spreadsheets and fretting over the contents of 1099-Q and 1098-T forms! Not to mention trying to keep actual spending documentation for some kid who thinks I'm nuts for trying to collect actual spending documentation. I hope the google machine leads unsuspecting parents to this post so they can have an easier time of it than I had.


That's a good point. A good reason for leaving it there is that it's making a couple percent better than I'd get "on the outside". The question I've been pondering is "why not now?", and I think because the grad school question hasn't been completely ruled out, December is probably a better time-frame. Of course in or out of the 529, it could be used for grad school, just that the gains would get taxed, but at her low rate. Of course she could blow the wad of cash on something other than school then!


This is a logical view, certainly. But we're talking about US tax law . From what I understand, student loans are not a qualified education expense. That's understandable because they let you pull-out, tax-free, the amount school costs; you "should" do that and just not take-out loans if there's still money in the 529. But I couldn't walk away from interest free loans, so didn't do it that way.

One thing I wish I knew at the beginning was how to execute the distributions from the 529. At first, I was paying the school directly out of the 529. But there were expenses that were qualified education expenses that didn't go to the school...lots of expenses, like room and board, books and supplies, health insurance, travel to and from. So I tried to keep track of the actual expenses, then remember to get a check cut to myself (or the student) for that amount. That was a real pain.

If I had to do it all over again, when they went-off in the fall, I'd pull out the entire school-year's budget in one transaction. Money would come out payable to the student. Stick it in an account where the student and I both had access, but with her as primary (this would only work with a trustworthy kid). The agreement would be that I'd be the one to initiate transfers to her spending account. Based on the EFC, I'd set-up a weekly transfer to her spending account. I've done this weekly transfer thing for most of the time my second student was in school, but didn't do the once a year pull from the 529 in the amount of the published school budget.

When it comes to using the actual expenses versus published school budget, I didn't read-up on it, but how far off could I be from the budget? Tuition/fees, Room & Board, Books and Supplies (including a computer & keeping it running) make up 90% of the budget, and I paid for that stuff, for sure. The principle is that whatever the "rack rate" is for those things and other qualified expenses is what comes out of the 529 tax-free.
Your qualified education expenses are based on your ACTUAL costs regarding eligible educational expenses, the published school budget has nothing to do with what you actually spent or your allowed 529 distribution. However, it could apply as a maximum regarding room and board.

To quote from savingforcollege.com:
"QHEE includes tuition, fees, books, supplies, computers and related equipment, and the additional expenses of a "special needs" beneficiary. For students who are pursuing a degree on at least a half-time basis, QHEE also includes a limited amount of room and board. You CANNOT include the following expenses:

Insurance, sports or club activity fees, and many other types of fees that may be charged to your students but are not required as a condition of enrollment
Transportation costs
Repayment of student loans
Room and board costs in excess of the amount the school includes in its "cost of attendance" figures for federal financial aid purposes. If your student is living off campus, ask the financial aid department for the room and board allowance for students living at home with parents, or living elsewhere off campus, as the case may be. If the student is living in campus-owned dormitories, the amount you can include in QHEE is the amount the school charges for its room and board."
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Old 08-20-2016, 08:37 PM   #7
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Thanks for the interpretation, RE. I'm not up against the max allowable anyway, and as I mentioned, 90% of the school's published student budget is for the big ticket items. Those are front and center in the early dorm years, so tracking the big stuff (actual costs) is easy. My kids used food plans and dorms, and that's right in the university bill. When they get an apartment and shop at the grocery store, actuals are harder to come-by. But I'm still thinking that trying to keep track of everything spent is too much trouble. Presuming my kid is spending at the level of the published budget is probably a good assumption. There's several budgets to choose from, on campus, off campus independent, off campus with parents.

My recommendation to those entering the fray... don't attempt to track every dime. Use the budget, especially if your 529 is funded at a level that would not cover 4 years without assistance.
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Old 08-20-2016, 09:11 PM   #8
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I guess before I paid the tax and penalty I would consider a top of the line computer, router, etc and any degree related equipment she may need when she starts work, if you feel that's within the spirit of the rules.
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Old 08-21-2016, 02:12 PM   #9
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Good thought, but I'm not sure it would work for me. Tax on gains and any penalty would be reported in the beneficiary's tax calculation. Since the only income they have are these gains, it often ends up not having any meaning (all happens the zero percent tax bracket).
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Old 08-21-2016, 04:13 PM   #10
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I believe you can transfer the money to use for any family member including yourself. Any other upcoming schooling in the family?
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Old 08-24-2016, 08:01 PM   #11
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Yes, the beneficiary assignment rules are fairly liberal, as long as it's in the extended family. The obvious choice for me is to let it compound for 20 years or more for the grandchildren. But no grandkids on the radar at all right now, but I think nieces and nephews are in the list, and I've got plenty of those of all ages.
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Old 08-24-2016, 09:49 PM   #12
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What if she decides to go to grad school? That option is now on the table for DS. Few positions have shown up in 3 states he's looking at and he is working out how to work in the meantime. He is much more likely to land a teaching position with a master's degree and they get a higher pay scale automatically.

You may want to hold onto the account a bit longer.
Sengsational--thanks for starting this thread.
My DD is also a senior and we are keeping our 529 accounts active in anticipation of her going to graduate school.

Best Wishes,
Rick
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Old 12-07-2016, 01:04 PM   #13
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Here is a Q and A that someone just getting into paying out of a 529 might like to read. I wish I'd had this information when my kids were first entering college, since I did leave a lot on the table, tax-wise.

income tax - What is a good strategy for an over-funded 529 account? - Personal Finance & Money Stack Exchange
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