529's - cashing them in AFTER child finishes college?

[simple girl]

Hi all,

A friend of mine told me his broker told him the following:

"Unless the Fed changes the law, I can hold on to my kids 529 college plans until they recover to what ever number I think is good. This can be years after they graduate. I hold on to the receipts I paid for college and as long as the accounts are no larger than what I paid, I can cash them out in the future, tax free."


Having no kids, I know virtually nothing about 529's, but I'm wary of the above advice. I searched the web and didn't find anything saying this was allowable. I did find info saying you can transfer the 529's into a younger child's name, etc., but I found nothing saying you can cash them out years later.

Does anyone know anything about this?

 

[OAG]

I think what your friend told you (based on the broker) seems a tad incorrect. Here is a short answer to almos the exact question someone else had regarding closing the 529: Closing 529 plan triggers tax headaches

 

[LOL!]

I read OAG's link and it really is not related to the OP's question. In the link, they closed the 529 plan instead of moving their money to a CD or fixed income fund WITHIN the 529 plan. The OP in contrast is asking if the educational expenses can be paid from a 529 plan in a year other than when they are incurred.

 

[OAG]

I guess I misread the question: "I can cash them out in the future, tax free". I thought cash them out was "closing" the 529.

 

[simple girl]

The OP in contrast is asking if the educational expenses can be paid from a 529 plan in a year other than when they are incurred.

Yes, this is exactly what I am asking. Thank you for summarizing it more clearly. Does any one have an answer?

I guess I misread the question: "I can cash them out in the future, tax free". I thought cash them out was "closing" the 529.

Thanks for trying to help OAG!

 

[kaneohe]

just for fun, googled "529 pay later year" and got this
Joe Hurley's question and answers on 529 Plans

There were others links too which I didn't read. This one sounds a cautionary note to try to have the charge/payment in same year.

might be interesting to do same w/ HSA which many feel you can have
charge/payment not related to same yr.

 

[FUEGO]

might be interesting to do same w/ HSA which many feel you can have
charge/payment not related to same yr.

I've researched the heck out of it and I'm fairly confident HSA reimbursements can be paid out any time after the expenses occur as long as the expense reimbursements occur prior to the death of the HSA owner. Except for expenses incurred within the year prior to the HSA owner's death, which can be reimbursed after death (or something like that).

Bottom line is you can wait for 10-20 years and keep a box of receipts from which you can reimburse when you need a Roth-like distribution of cash.

No idea if the 529 has the same rules.

 

[dshibb]

It is a viable strategy, but keep in mind that interest isn't added, so the longer you wait the more beneficial it is to the IRS. In other words inflation makes sure that the expenses are more valuable in terms of purchasing power in the year in which they are incurred than several years later. To determine if it is worth it or not you need to apply a formula to it. That formula would have to take your expected rate of return in the 529 and discount it back by the interest rate that you think you could get on that money if you reimbursed it that year.

Yes you can shift a 529 plan to another child. And in case you don't have any kids left to use it for, I just had an idea pop in my head. You could find relatives and friends that are planning on paying for their kids college, and you could have your 529 pay for that kid up to the gift tax exclusion amount, and then the parent could gift back to you. You would split the tax difference of you actually cashing in the plan and getting hit with the taxes.

 

[kaneohe]

It is a viable strategy, but keep in mind that interest isn't added, so the longer you wait the more beneficial it is to the IRS. In other words inflation makes sure that the expenses are more valuable in terms of purchasing power in the year in which they are incurred than several years later. To determine if it is worth it or not you need to apply a formula to it. That formula would have to take your expected rate of return in the 529 and discount it back by the interest rate that you think you could get on that money if you reimbursed it that year.

Yes you can shift a 529 plan to another child........

I'm assuming your first paragraph is about 529s? Doesn't the 529 keep earning while the funds are there & don't the funds come out tax free for qualified education expenses? If so, why isn't it to your benefit to leave the funds in the 529 as long as possible and pay them in later yrs if it is ok w/ the rules.......this would be like the HSA strategy that seems more people agree on as a good strategy.

 

[FinanceDude]

Just saw this thread. Per usual, the IRS is murky on HOW distributions are handled. Technically, you can wait until you want to reimburse. However, every client that I have who has a 529 takes a disbursement when they get the tuition bill from the college. I saw Joe Hurley live in 2002 when he hit our area. he did admit that 529's were an evolving thing..........

A lot fo these plans took a big hit last year in the market. Until the sunset provision, folks can take money out federal tax free and most states also don't charge state tax on them, so technically tax-free distribution.

The only time a tax is computed is when someone cashes out of the plan and doesn't use the money for anyone's education. You then pay a tax on the GAINS of the portfolio, not the return of principal. Of course, YOU need to keep the records that can verify this.........

I should also throw in there that most of not all plans allow parents to take custodial accounts and put them into a 529. The parents need to sign a form that they understand that custodial accounts are irrevocable gifts and they need to inform their child when they are of age that its THEIR money.........

 

[dshibb]

"I'm assuming your first paragraph is about 529s? Doesn't the 529 keep earning while the funds are there & don't the funds come out tax free for qualified education expenses? If so, why isn't it to your benefit to leave the funds in the 529 as long as possible and pay them in later yrs if it is ok w/ the rules.......this would be like the HSA strategy that seems more people agree on as a good strategy."
Yes I am talking about 529s. You're not understanding that the money that could be reimbursed today is worth more than that same money being reimbursed in the future, you should at least account for inflation, but I'd account for returns earned on the money you would receive today.

Example: The amount of school expenses to reimburse is 10K. You have paid out that amount and lost the future earnings of that money until you reimburse yourself out of the 529. By electing to wait to reimburse until a later day you are giving the IRS an interest free loan, in exchange for tax free growth. I'm not positive on the formula, but it would appear that you would have to discount the rate of return earned in the 529 by .85(1 minus capital gains) if you were to invest that money outside of a tax preferred vehicle in the same manner as you did inside the 529. If you don't max out all your tax preferred vehicles than the shifting of this reimbursed money to this tax preferred vehicle would produce a wash. After all of that then you have to discount the money being earned by the risk of having more money in the 529 than there are in education expenses because in that event taxes are paid on closing the 529.


Essentially I would use the delayed reimbursement if this was my situation. I had multiple kids and I didn't think there was enough in my 529(s), to cover all of it. I would accumulate the eventual reimbursements until all three went through college and then I would let the 529 accumulate until all of the reimbursements were made up for and then cash it in and close the account. The key here is whether or not you are going to continue to use it, if you are done using the 529 there is no point in allowing it to accumulate past your total reimbursements. An HSA will be used for life, so it pays to defer those reimbursements for a long time and until it has grown substantially.

 

[kaneohe]

Yes I am talking about 529s. You're not understanding that the money that could be reimbursed today is worth more than that same money being reimbursed in the future, you should at least account for inflation, but I'd account for returns earned on the money you would receive today.

Example: The amount of school expenses to reimburse is 10K. You have paid out that amount and lost the future earnings of that money until you reimburse yourself out of the 529. By electing to wait to reimburse until a later day you are giving the IRS an interest free loan, in exchange for tax free growth. I'm not positive on the formula, but it would appear that you would have to discount the rate of return earned in the 529 by .85(1 minus capital gains) if you were to invest that money outside of a tax preferred vehicle in the same manner as you did inside the 529. If you don't max out all your tax preferred vehicles than the shifting of this reimbursed money to this tax preferred vehicle would produce a wash. After all of that then you have to discount the money being earned by the risk of having more money in the 529 than there are in education expenses because in that event taxes are paid on closing the 529.

dshibb,

not quite sure if we're disagreeing or not. First, I agree w/ you that the 529 should not be overfunded beyond the QHEE else you end up paying taxes/penalty on the excess. Assuming that does not happen tho...... you can either : 1) pay expenses from outside funds and leave 529 intact to grow tax free or 2) pay expenses from 529 and leave outside funds funds to grow in taxable manner.
Ex: assume 10K QHEE, 10K in outside fund, 10K in 529.
1)pay 10K QHEE from outside fund leaving 0 balance there and 10K in 529
2) pay 10K QHEE from 529 plan leaving 0 balance there and 10K in outside taxable account

Isn't the 10K in the 529 plan going to grow faster and larger than the taxable account? I think this is the same idea behind trying to leave the HSA intact. ......
and in OP, the condition is to keep 529 smaller than the QHEE so no taxes/penalties.
However, if IRS rules that expenses and distributions must be in same yr, that would end the discusssion.

 

[dshibb]

I don't think we are disagreeing here. The assumptions are that you don't go past QHEE, and that you don't have another tax free vehicle that you can stick the money into, if you have another need. Keep in mind though that the IRS still doesn't mind that you are taking the reimbursement later because there is no interest added to that reimbursement amount.