I believe I can take withdrawals up to the scholarships amount. I would need to pay taxes on the gains but not a penalty. Anyone know how to go about documenting that? The gains are roughly half the accounts value.
Any thoughts on what to do with these funds?
You're correct on the scholarships. The gains portion would be taxed as ordinary income (on your return if you send the money to yourself, on your kid's return if you send the money to them) and reported on Form 1040 line 8z - see IRS Pub 970 chapter on QTPs (which is what the IRS calls 529s).
It appears that you simply don't report the penalty in the case of a scholarship. Of course keep records of the scholarship information with your or their tax return.
As far as what to do with the funds, in addition to the options already mentioned (use up for qualified expenses, distribute and pay taxes on gains, Roth rollover, keep for graduate school), you might also consider keeping them as an educational trust fund if you anticipate grandchildren. Although you might have too much left over - something to think about.
this is great. I did not know this. Though it still looks like its capped at (currently) $6500/year and they have the beneficiary would have to have at least that much earned income.
The article doesn't make it super clear but it looks like I an avoid both the penalty AND the tax if I simply roll it over to the the beneficiary's Roth IRA, correct?
Correct. It's considered a qualified distribution from the 529, and therefore is completely tax and penalty free.
There are a lot of other rules, as others have pointed out. The text of the law is pretty readable, but I'm sure there will be blog articles in the usual personal finances spots that outline them.
I'm planning to use the roll over to Roth option when its available in 2024, but there are a bunch of rules to be able to do that. The 529 account has to be open for 15 years. Also, if you have moved or rolled any over to a different beneficiary's 529, I believe it restarts the clock, so if you are thinking of pursuing this ROTH option, don't try to move funds to a different kid's 529. This is going to be a great option to use excess 529 funds, but I get the impression its going to be tricky with potential hiccups for many people.
I don't personally believe that a rollover from one beneficiary's account to another beneficiary's account would restart the clock, but changing the beneficiary name on an account would. The text of the law is very terse on this point, though, so I expect we'll get guidance from the IRS at some point.
Definitely need more guidance on the Roth roll over rules. It says that contributions for the last five years can’t be rolled over but how do I know which funds are being transferred? I use the Ohio 529 plan (the CA plan options were terrible at the time I opened them 15 years ago).
I assume it must be FIFO but I did not see any option to withdraw specific lots.
The last contribution to my kids accounts was last year.
I assume if i rolled over some funds from my oldest kids account to my younger kids, it will need to sit in my younger kids account until I could do a Roth rollover. Hopefully we’ll get some guidance on this.
I assume FIFO as well, but agree that will be something that needs to be sorted out.
As far as the five year rule goes, I assume that as long as the remaining balance in the 529 is greater than the last five years of contributions, then I'm OK. That's not a great rule, though, because it ignores earnings.
Personally I would make sure I leave any intra-kid rollover funds in the second kid's account for five years. As long as that rule is met, and the second kid's account itself is over 15 years, I think that meets the letter and spirit of the law.
Again, though, we should get better guidance on this sometime next year. With the IRS' recent track record on timeliness, I personally don't expect anything until late 2024.
