529 non-qualified withdrawal tax question

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Topic Author
Theseus
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529 non-qualified withdrawal tax question

Post by Theseus »

I contributed lump sum amount to my two DD's 529 accounts in 2012 and put it in S&P500 that was about 1350 back then. I estimated it to grow 7% annually to fully fund the college. But S&P has tripled since then. Older daughter just graduated this spring with still enough left in the account to go to school all over again. She has accepted a job that she will start in September but is thinking of pursuing MBA in the future (where her employer will contribute $10k/year if she stays with them).

The younger one still has 3 years before she starts college and she has enough in her account to send four kids to college (in-state). I have already moved a portion in safe investment that will be for her college. The rest is in S&P500.

My question is for older DD's leftover money. I am thinking of outright distributing all or some of this money to her as a non-qualified withdrawal(she is very responsible and I have no issue doing this). This will be taxed at her income tax level of this year. She has no other income, and only income will be starting in September and for 2021 she will gross about $45,000. So I am thinking even with 10% penalty on the earnings, at her income tax rate of this year is better. Has anyone done anything like this? Or is there a better option(no other family member needs the college money)?

I know I can leave this money to the grand kids (when that happens), but by then it will probably grow to some insane amount that if withdrawn will have much higher tax and penalty.

And I still don't know what to do with younger DD's excess money.
mschurner
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Re: 529 non-qualified withdrawal tax question

Post by mschurner »

I think for non qualified withdrawal, you will pay the penalty and interest, not your daughter. I might be wrong. Interested to hear from other BH stalwarts.
Topic Author
Theseus
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Re: 529 non-qualified withdrawal tax question

Post by Theseus »

mschurner wrote: Tue May 18, 2021 11:15 am I think for non qualified withdrawal, you will pay the penalty and interest, not your daughter. I might be wrong. Interested to hear from other BH stalwarts.
If I take the money back then it will be taxed at my rate. But if I distribute to the beneficiary (DD) then the beneficiary’s tax rate applies. At least that’s what I read.
neverpanic
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Re: 529 non-qualified withdrawal tax question

Post by neverpanic »

mschurner wrote: Tue May 18, 2021 11:15 am I think for non qualified withdrawal, you will pay the penalty and interest, not your daughter. I might be wrong. Interested to hear from other BH stalwarts.
Whoever receives the non-qualified 529 distribution is the one who reports the income and pays the appropriate tax and penalty.

OP - Here's a pretty thorough article from 2020 which addresses your situation:

https://www.marottaonmoney.com/qa-who-p ... s-and-how/
I am not a financial professional or guru. I'm a schmuck who got lucky 10 times. Such is the life of the trader.
Topic Author
Theseus
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Re: 529 non-qualified withdrawal tax question

Post by Theseus »

neverpanic wrote: Tue May 18, 2021 11:21 am
mschurner wrote: Tue May 18, 2021 11:15 am I think for non qualified withdrawal, you will pay the penalty and interest, not your daughter. I might be wrong. Interested to hear from other BH stalwarts.
Whoever receives the non-qualified 529 distribution is the one who reports the income and pays the appropriate tax and penalty.

OP - Here's a pretty thorough article from 2020 which addresses your situation:

https://www.marottaonmoney.com/qa-who-p ... s-and-how/
Thank you. This is exactly what I was looking for. This even gives instructions on tax return and where to report. So all I need to do now is to a pro forma tax return for DD for tax year 2021 and see the impact - of course this will be based on the current tax laws.
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vineviz
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Re: 529 non-qualified withdrawal tax question

Post by vineviz »

Theseus wrote: Tue May 18, 2021 10:53 am My question is for older DD's leftover money. I am thinking of outright distributing all or some of this money to her as a non-qualified withdrawal(she is very responsible and I have no issue doing this). This will be taxed at her income tax level of this year. She has no other income, and only income will be starting in September and for 2021 she will gross about $45,000. So I am thinking even with 10% penalty on the earnings, at her income tax rate of this year is better. Has anyone done anything like this? Or is there a better option(no other family member needs the college money)?
Transferring ownership of account to your daughter probably the best way to manage the overfunding, assuming (as you say) you trust her with the money. It's unlikely her income will ever be lower than it is this year, so paying the tax on the 529 unqualified withdrawal probably will make sense.

If she's eligible to contribute to a 401k at her new job, maxing out the contribution for 2021 and contributing the maximum amount to a traditional IRA might possibly allow her to withdraw a good portion of the 529 and still remain in the 12% bracket for the year.

It might make sense to withdraw up to the 22% bracket, but if there's a chance that she'll pursue a full-time MBA program that might give her a few years where she'll be back down in the 12% bracket.

Also, the cost of my MBA was far more than $10k/year.
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Topic Author
Theseus
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Re: 529 non-qualified withdrawal tax question

Post by Theseus »

vineviz wrote: Tue May 18, 2021 11:37 am
Theseus wrote: Tue May 18, 2021 10:53 am My question is for older DD's leftover money. I am thinking of outright distributing all or some of this money to her as a non-qualified withdrawal(she is very responsible and I have no issue doing this). This will be taxed at her income tax level of this year. She has no other income, and only income will be starting in September and for 2021 she will gross about $45,000. So I am thinking even with 10% penalty on the earnings, at her income tax rate of this year is better. Has anyone done anything like this? Or is there a better option(no other family member needs the college money)?
Transferring ownership of account to your daughter probably the best way to manage the overfunding, assuming (as you say) you trust her with the money. It's unlikely her income will ever be lower than it is this year, so paying the tax on the 529 unqualified withdrawal probably will make sense.

If she's eligible to contribute to a 401k at her new job, maxing out the contribution for 2021 and contributing the maximum amount to a traditional IRA might possibly allow her to withdraw a good portion of the 529 and still remain in the 12% bracket for the year.

It might make sense to withdraw up to the 22% bracket, but if there's a chance that she'll pursue a full-time MBA program that might give her a few years where she'll be back down in the 12% bracket.

Also, the cost of my MBA was far more than $10k/year.
Thanks. I didn't think of 401k and IRA contributions to bring the income down. I will model that as well.
ZMonet
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Re: 529 non-qualified withdrawal tax question

Post by ZMonet »

I realize there are a number of ifs involved, but IF you think your daughters will have children, wouldn't the money be better left to grow and fund future generation educational wealth? Now your situation seems somewhat unique in that your daughter in is a position where the penalty + tax won't hurt much AND you trust her with money, but it just seems inefficient if you plan to contribute to your grandchildren in the future anyway.
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Theseus
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Re: 529 non-qualified withdrawal tax question

Post by Theseus »

ZMonet wrote: Tue May 18, 2021 6:49 pm I realize there are a number of ifs involved, but IF you think your daughters will have children, wouldn't the money be better left to grow and fund future generation educational wealth? Now your situation seems somewhat unique in that your daughter in is a position where the penalty + tax won't hurt much AND you trust her with money, but it just seems inefficient if you plan to contribute to your grandchildren in the future anyway.
Yes. I thought of that. But her being 22, her first child (assuming she has a kid at 30) will need the college money in 22 years. That pot could grow way too large by then and She will be in the situation I am in or worse(I know this a good problem to have- but still). Perhaps I distribute some now and leave some for her MBA and her kids.

My younger daughter - freshman in high school- has $280K in 529! Unless she goes to medical school I don’t see most of this money being used. And if left alone it will compound to some insane value in 30 years when her child may need it.

Embarrassment of the riches :oops:
carloslando
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Re: 529 non-qualified withdrawal tax question

Post by carloslando »

Theseus wrote: Tue May 18, 2021 7:03 pm
ZMonet wrote: Tue May 18, 2021 6:49 pm I realize there are a number of ifs involved, but IF you think your daughters will have children, wouldn't the money be better left to grow and fund future generation educational wealth? Now your situation seems somewhat unique in that your daughter in is a position where the penalty + tax won't hurt much AND you trust her with money, but it just seems inefficient if you plan to contribute to your grandchildren in the future anyway.
Yes. I thought of that. But her being 22, her first child (assuming she has a kid at 30) will need the college money in 22 years. That pot could grow way too large by then and She will be in the situation I am in or worse(I know this a good problem to have- but still). Perhaps I distribute some now and leave some for her MBA and her kids.

My younger daughter - freshman in high school- has $280K in 529! Unless she goes to medical school I don’t see most of this money being used. And if left alone it will compound to some insane value in 30 years when her child may need it.

Embarrassment of the riches :oops:
A private engineering school running $80K/year (Stanford etc) too could end up using all of that.
Comparison is the killer of all joy.
DIFAR31
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Re: 529 non-qualified withdrawal tax question

Post by DIFAR31 »

I can think of far greater problems than having "too much money" in education-specific investment accounts that allow for both tax-free growth and withdrawals and don't have any required minimum distributions - ever. Turn your "problem" into a plan to fund the educations of future generations of the Theseus family for as long as it can be done. Your kids, your grandchildren, your great-grandchildren, etc. will thank you. Money = options, and the more options the better for high school students trying to figure out where they can go to college.
marcopolo
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Re: 529 non-qualified withdrawal tax question

Post by marcopolo »

Theseus wrote: Tue May 18, 2021 7:03 pm
ZMonet wrote: Tue May 18, 2021 6:49 pm I realize there are a number of ifs involved, but IF you think your daughters will have children, wouldn't the money be better left to grow and fund future generation educational wealth? Now your situation seems somewhat unique in that your daughter in is a position where the penalty + tax won't hurt much AND you trust her with money, but it just seems inefficient if you plan to contribute to your grandchildren in the future anyway.
Yes. I thought of that. But her being 22, her first child (assuming she has a kid at 30) will need the college money in 22 years. That pot could grow way too large by then and She will be in the situation I am in or worse(I know this a good problem to have- but still). Perhaps I distribute some now and leave some for her MBA and her kids.

My younger daughter - freshman in high school- has $280K in 529! Unless she goes to medical school I don’t see most of this money being used. And if left alone it will compound to some insane value in 30 years when her child may need it.

Embarrassment of the riches :oops:
My older son ended up with over $200k left over in his 529, even after paying for portion of masters program. Younger son is on similar path.

I considered taking much of it out at his tax rate, but he is already earning enough money to be in a fairly high tax bracket as a single filer.

We decided that we are OK leaving it in place for future generation(s). The tax free growth seems very valuable.

If each child has multiple children, it will likely be used up in a generation or two.

As you alluded to, it is a good problem to have.
Once in a while you get shown the light, in the strangest of places if you look at it right.
ZMonet
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Re: 529 non-qualified withdrawal tax question

Post by ZMonet »

Theseus wrote: Tue May 18, 2021 7:03 pm
ZMonet wrote: Tue May 18, 2021 6:49 pm I realize there are a number of ifs involved, but IF you think your daughters will have children, wouldn't the money be better left to grow and fund future generation educational wealth? Now your situation seems somewhat unique in that your daughter in is a position where the penalty + tax won't hurt much AND you trust her with money, but it just seems inefficient if you plan to contribute to your grandchildren in the future anyway.
My younger daughter - freshman in high school- has $280K in 529! Unless she goes to medical school I don’t see most of this money being used. And if left alone it will compound to some insane value in 30 years when her child may need it.

Embarrassment of the riches :oops:
My youngest has about that in her 529 and she is in middle school. As others have said, education costs per year can have a huge spread so that money could be eaten up by certain 4-year schools. Obviously an individual decision, but if the "worst case" happens and my daughter has a ton leftover, then it isn't so bad to be building educational multigenerational wealth.
Topic Author
Theseus
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Re: 529 non-qualified withdrawal tax question

Post by Theseus »

I think based on some of the comments here, I am inclined to leave the $ in the 529 and let the future generations have access to it. Thanks all for the good information.
fyre4ce
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Re: 529 non-qualified withdrawal tax question

Post by fyre4ce »

I second the idea of keeping at least most of it inside the account for future generations. Speaking for myself, my spouse and I have done great financially (NW ~$3M in our mid-30's), but we just bought a 4-bedroom house in a VHCOL area and despite having a good income and no other debt, the mortgage payment is a squeeze on our budget compared to when we were renting. Shoveling money into a 529 doesn't feel like a great idea when we should be building back up taxable savings and/or throwing extra money at the mortgage (our lender allows recasts, which we plan to do). So far we are contributing $5k/year for our one child, plus I have a family member contributing the same amount to a plan in their state. But if/when your daughter has a family, she may be in a similar situation with other financial priorities, and knowing that college savings for her children is covered could be a great value, even if she and her future spouse do everything right.

Withdrawing up to the top of her 12% bracket (22% with penalty) seems reasonable, but this sounds like a small fraction of the total balance. I'd leave the rest in the plan, and ditto for the younger daughter in high school if there's any left over after undergrad.
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southerndoc
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Re: 529 non-qualified withdrawal tax question

Post by southerndoc »

This varies by state. Georgia's 529 plan (Path2College) states:
https://www.path2college529.com/documents/ga_plan_description.pdf]A Qualified Withdrawal will not be subject to Georgia income tax. The earnings portion of a Taxable Withdrawal or a
Non-Qualified Withdrawal (referred to as an “Unqualified Withdrawal” under Georgia statutes) will be taxed to the
Account Owner to the extent it would be subject to federal income tax if the Account Owner were considered to be
the recipient
. In such a situation, the Account Owner is taxed even if earnings on the Account are attributable to
contributions by another person
. If the Taxable Withdrawal or Non-Qualified Withdrawal is paid to the Beneficiary
and is included in the Beneficiary’s federal adjusted gross income, the Beneficiary may subtract for Georgia income
tax purposes the amount included in federal adjusted gross income provided the Account Owner has added the
amount for Georgia income tax purposes
. See also the potential for recapture of amounts previously deducted
under the caption “Recapture” below.
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