Getting Money Out of the 529 Account

[sengsational]

It looks like I'm going to have a remaining balance after my two kids get done with their undergraduate degrees. I wondered about my options to close out the accounts with minimal taxes and penalties.

• DD1 finishing up a degree at a private university this year, job offer accepted.
• DD1 529 account going to be empty after the spring tuition bill gets paid.
• DD1 will have 15K in loans at the end.
• DD1 will have received about 85K in discounts over the 4 years (lableled as 'scolarship' on the tuition bill, but I call 'em discounts).

• DD2 just starting out at a public university.
• DD2 529 has $125K.
• DD2 expenses 1st year: 14K, remaining 3 years: $19K*3 ($71K for 4 years).
• DD2 will have 5K in loans at the end.
• DD2 will have received no discounts/scholarships.

My kids came up with this idea idenpendently: After DD1 starts work next July, change the beneficiary on DD2's account to DD1, pay off the loans, then switch the beneficiary back to DD2. The plan was that DD2 will "tote the note" for her older sister . Or maybe there's a way to do a 529 to 529 transfer that doesn't have tax consequences?



Anyway, those numbers show $34K left in DD2's 529 after the undergraduate degree (125-71-15-5=$34K). I told the girls that that the remainder of their 529 account was theirs after they graduated college (an incentive to go to a state school and/or be conservative).


So although I could keep the account, changing the beneficiary on the account to a grandchild (if one ever happens), or to a neice or nephew or whatever, and gift the equivalent cash to DD2, I figured it would be better to just get the money out, giving it to DD2, and close out the account.


A thread I read just today (about the guy with 5 or 6MM net worth) had a set of side details about the ability to getting money out of 529's (without penalty, but counting gains as income) up to the amount of the scholarships received. So it looks like that might work for me. Can I go back and claim all of those scholarships received (starting in 2010) at a later point in time (after DD2 wraps up her undergraduate degree)? So in 2017, I guess I'd change the beneficiary to DD1, pull all of the money out and somehow document that there was scholarships received all those years ago?

 

[karluk]

My kids came up with this idea idenpendently: After DD1 starts work next July, change the beneficiary on DD2's account to DD1, pay off the loans, then switch the beneficiary back to DD2.

That would be a good idea, if the tax laws allowed it, but I'm afraid that paying off student loans is not a qualified education expense from the point of view of making 529 withdrawals. That's my understanding at least, and a quick internet search confirms it. For example,

Is paying off a student loan a qualified higher education expense?
No. There are a number of expenses for which you can use the assets of a 529 plan, but repayment of student loans is not one of them.

529.com - Using Your 529 Plan Account

 

[kaneohe]

You can take funds out if you get a scholarship w/ no penalty. However you the recipient will be taxed on that withdrawal. Possibly she will be in a low tax bracket the first yr of work. See item 2 here
Avoid These 529 Withdrawal Traps

 

[sengsational]

That would be a good idea, if the tax laws allowed it, but I'm afraid that paying off student loans is not a qualified education expense from the point of view of making 529 withdrawals. That's my understanding at least, and a quick internet search confirms it. For example,

Is paying off a student loan a qualified higher education expense?
No. There are a number of expenses for which you can use the assets of a 529 plan, but repayment of student loans is not one of them.

How silly of me to think that debit incurred to pay an approved educational institution could be confused with paying that same approved educational institution. Logic goes out the window again. So that means the amount 'stuck' in the 529 is $49K instead of $34K. I can only hope that the old scholarships are in play.

 

[sengsational]

You can take funds out if you get a scholarship w/ no penalty. However you the recipient will be taxed on that withdrawal. Possibly she will be in a low tax bracket the first yr of work. See item 2 here
Avoid These 529 Withdrawal Traps

Thanks for that link. It's sounding like the old scholarships (from past years) are off the table? If that's so, then I would need to act before year-end to make 2013 scholarship withdrawls. This would avoid the 10% penalty but require me or DD to pay tax on the gains. 2013 would be $24K in scholarship withdrawls and 2014 would be 16K in scholarship withdrawls.

Taxes would be collected on the gains of $40K, but I'd be down to only about $14K in the account at the end (125-71-40=$14K).

 

[RE2Boys]

This link may help regarding past scholarships:

The Best Way to Withdraw 529 Funds

 

[Gabieta]

This link may help regarding past scholarships:

The Best Way to Withdraw 529 Funds

Thanks for the link, RE2Boys. Very informative!

 

[kaneohe]

This link may help regarding past scholarships:

The Best Way to Withdraw 529 Funds

Yup, you deserve a finder's fee on that one. Think sengsational is going to be thrilled.

 

[NH Hiker]

This link may help regarding past scholarships:

The Best Way to Withdraw 529 Funds

I am sure the tax experts know what they are doing, but just to be safe, I try to keep the withdrawals in the same year. In turbotax, the 1098-T amounts and the 1099-Q amounts are used when calculating the waiver amount due to scholarships. In addition, I also make sure the withdrawal check goes to the student so nothing is on my return.