529 Withdrawal and Stafford loan for Medical School

[retire2020]

My daughter is in Medical School and I have about 250K(80K my contribution and 170K in gain) in 529 plan. I am the owner of 529 and she is the beneficiary. By filling out the FAFSA she automatically qualifies and receives 40.5K of un-subsidized Stafford loan. Her yearly expense would be about 60K(45K Tuition and 15K room and board). I claim my daughter as dependent on my tax returns. Can I do following?

1) Take the loan which is 40.5K
2) But withdraw 60K from 529 plan...full qualified expense
3) I will receive 1098-T from her college stating 60K was paid

Basically what I am trying to do is withdraw full expense from 529 but also use stafford loan to pay for part of the same expenses. I'll save that extra withdrawal of 40.5K from 529 for future use. Is it allowed and within rules? Does IRS care or they only look at 1098-T that expense was indeed paid?

This way if daughter in future gets a job offer where employer pays for student loan(have read few on reddit medical forum where employer offered to pay 40K/year for five years - total 200K student loan paid as part of the overall offer), she'll not miss that chance of not having student loan. If she doesnt get the similar deal then I'll help her pay student loan from the money saved from 529 withdrawal above.

I posted the same question at bogleheads but did not receive any firm answer so posting here as well.

I need to be absolutely sure of the law and what I am planning to do is legal otherwise 10% penalty and taxes on the earning. Any idea?

 

[sengsational]

Although one daughter still has a balance, and is taking the occasional class, I'm mostly through the 529 maze. I came through unscathed (most of this happened more than 7 years ago).

I wrote an answer on stackexchange that you might find enlightening. The way I did it was pretty simple. I started with the school's budget....it's what they estimate it costs for a year of school. Your actual might be higher or lower. Because I figured my actual expense would be higher, I figured I was safe with the budget number, and if there ever was an audit, I'd be able to put together proof of expenses at least that high.

Anyway, I took the budget number, subtracted scholarships and grants (which, in other businesses are called "discounts") and that's your real cost of education, and cut myself a check for that amount. The fact that you take a loan or don't take a loan is irrelevant.

The laws surrounding 529's allow you to remove, without penalty, scholarships and grants, but you DO need to pay tax on the gains. So in your case, if there were $1,000 in scholarships/grants and you had a check cut, you or the beneficiary would have to pay gains on $680.

This all occurred before the law was changed that allowed paying student loans with 529 funds up to the $10,000 lifetime limit. The $10K is small potatoes, though.

You should probably take this model and run it past an advisor and/or run it past what you read in the IRS documentation of the 529 and make sure it holds water.

 

[Phroig]

No tax and no penalties; see Pub. 970 https://www.irs.gov/publications/p970. You only pay a tax (but no penalty) if you have a tax-free scholarship/grant (for tuition and fees), and you still withdraw that amount. No tax/no penalty if the scholarship is taxable. This means you could have a scholarship for room and board, and still withdraw the amount from your 529. Distributions for room/board can't exceed the amount specified by the school.

 

[rodi]

Can I piggyback off this 529 question?

TLR version first:
If son lives off campus, and goes to school fulltime at a community college that doesn't offer housing/dorms, can we use an out of date estimate of expenses I found on their website to justify the room & board expenses for 529 purposes.

Longer version:
Older son has been going to community college 1/2 time while working to get his GPA back up and develop better study habits. (He had a disastrous freshman year at a 4 year university living on campus.) He lives in a shared house and has cheap rent. We pay the direct school expenses currently but he pays his own rent. He's got 3 semesters of straight A's under his belt and we feel (as does he) that he's ready to go back to school full time in the fall. He'll cut back his work hours. His community college does not have dorms but does have a webpage to with a net price calculator that shows what room and board would be. That page is out of date, however. (2017-18 school year.) Can we use that figure to cover his room and board? and pull it from the 529?
https://www.mtsac.edu/about/why-mt-sac/compare-costs.html scroll down to net price calculator

His path back to a CSU requires he finish the 60 units at the community college and transfer. So he can't just go back to the CSU - he has to do his time at the community college. But perhaps their figures would work since he's only a few miles from his old campus... The CSU estimate still uses an old date (2019) - but is $3k higher.

Sorry for the hijack - I'm pretty sure I can use the figures given - but maybe someone knows a reason I can't.

 

[retire2020]

Although one daughter still has a balance, and is taking the occasional class, I'm mostly through the 529 maze. I came through unscathed (most of this happened more than 7 years ago).



I wrote an answer on stackexchange that you might find enlightening. The way I did it was pretty simple. I started with the school's budget....it's what they estimate it costs for a year of school. Your actual might be higher or lower. Because I figured my actual expense would be higher, I figured I was safe with the budget number, and if there ever was an audit, I'd be able to put together proof of expenses at least that high.



Anyway, I took the budget number, subtracted scholarships and grants (which, in other businesses are called "discounts") and that's your real cost of education, and cut myself a check for that amount. The fact that you take a loan or don't take a loan is irrelevant.



The laws surrounding 529's allow you to remove, without penalty, scholarships and grants, but you DO need to pay tax on the gains. So in your case, if there were $1,000 in scholarships/grants and you had a check cut, you or the beneficiary would have to pay gains on $680.



This all occurred before the law was changed that allowed paying student loans with 529 funds up to the $10,000 lifetime limit. The $10K is small potatoes, though.



You should probably take this model and run it past an advisor and/or run it past what you read in the IRS documentation of the 529 and make sure it holds water.

Thanks. I learned a lot from your post here and at stackexchange. Its a good problem to have when you have 529 overfunded. My plan is to withdraw enough funds without paying penalty and taxes. I'll leave around 50K in her account which eventually will get passed onto my grandkids. I also have twin boys going to college this fall so this strategy would perfectly work for them as well.

 

[retire2020]

No tax and no penalties; see Pub. 970 https://www.irs.gov/publications/p970. You only pay a tax (but no penalty) if you have a tax-free scholarship/grant (for tuition and fees), and you still withdraw that amount. No tax/no penalty if the scholarship is taxable. This means you could have a scholarship for room and board, and still withdraw the amount from your 529. Distributions for room/board can't exceed the amount specified by the school.

Thanks. One of my twin boys attending college this year may get a 5K scholarship for housing on the campus. As you mentioned that it'll be taxable so it will also be counted towards 'earned income'. So if my son doesnt end up working during college years(wants to be a Dr as well so entire focus for undergrad would be on shadowing, volunteer work and free research assistance) I can withdraw that 5K from 529 and fund his Roth IRA - At his tax rate that withdrawal will be almost tax free.

 

[Phroig]

Does your son get a W-2 for his scholarship? My son gets a 1098-t, so my understanding is no IRA contribution.

 

[retire2020]

Can I piggyback off this 529 question?

TLR version first:
If son lives off campus, and goes to school fulltime at a community college that doesn't offer housing/dorms, can we use an out of date estimate of expenses I found on their website to justify the room & board expenses for 529 purposes.

Sorry for the hijack - I'm pretty sure I can use the figures given - but maybe someone knows a reason I can't.

Rodi, Yes you can. I just did this for my daughter last year. Her medical college does not have dorms so my daughter rents out a room in three bedroom condo near her college. She pays $900 per month including utilities and has about $600 expense for food. When you stay off campus your rent+lodging expenses are qualified expenses for 529 withdrawal(but cant exceed cost estimated by college -- https://scarlethub.rutgers.edu/fina...ttendance/robert-wood-johnson-medical-school/). So I withdrew 18K and saved all the records and print out from the link I posted above just incase IRS has a query.

You can even withdraw some money as qualified 529 expense for room and board even if your son stayed home and attended a college

Expenses always go up with time and inflation so old estimate from college as a baseline would be just fine.

 

[Phroig]

Can I piggyback off this 529 question?

TLR version first:
If son lives off …
Sorry for the hijack - I'm pretty sure I can use the figures given - but maybe someone knows a reason I can't.

The school must have a current estimate. Have you tried emailing their Fin. Aid office?

 

[retire2020]

Does your son get a W-2 for his scholarship? My son gets a 1098-t, so my understanding is no IRA contribution.

My son starts college this fall so I dont know what I will get yet. But in any case, whether you receive a W2 or not, taxable scholarship should be reported on line 1 on 1040(mention SCH on dotted line) as per instruction on the same publication 970 link you posted earlier.

More info here —> https://www.investopedia.com/roth-ira-contributions-with-no-job-4770755

 

[Phroig]

My son starts college this fall so I dont know what I will get yet. But in any case, whether you receive a W2 or not, taxable scholarship should be reported on line 1 on 1040(mention SCH on dotted line) as per instruction on the same publication 970 link you posted earlier.

More info here —> https://www.investopedia.com/roth-ira-contributions-with-no-job-4770755

I agree. I was wondering about the Roth contribution.

 

[Phroig]

Also, no need to file if your son has no other income and the scholarship is less than $12,550.

 

[Phroig]

I just looked up Pub 590-A. Scholarships constitute compensation for IRA contributions only if reported on Box 1 of a W-2.