Hello,
My son will be starting college soon and I have been doing some reading on best practices. I am a bit confused and was looking for help.
We are not eligible for financial aid, and over the years, we created several different investment vehicles for our children: 1) UTMA 2) 529 Plan 3) Coverdell. We have money scattered over several different accounts. I’ve read that we should be careful not to withdraw more than the amount needed for qualified expenses (tuition, room, board, etc). The UTMA account unfortunately is not tax-free, so we want to drain that account first. Then our second choice is the Coverdell (since it must be used before age 30). Apart from this, I have a few questions:
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Should we have the 529/Coverdell disbursements sent directly to the college, or to our son, or to us (parents)? I’ve read differing opinions about this. If there are any tax consequences, is it better to disburse funds in kids name (lower tax bracket)? Unfortunately we will not be eligible for any tax credits (AOTC, Hope, etc).
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I read an article whose author suggested to use up all the 529 money, and even paying a penalty if there was money leftover. Well I just checked the balances of the accounts, and it looks like we will have a surplus of about $50K after 4 years. Wouldn’t it be better to keep the money in the 529 plan, and continue to earn interest? Son could then use it later if he decides to go to graduate school. Does this sound reasonable? Or is it better to drain the 529 after he graduates and pay the penalty?
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Disbursement timing: I’ve read that the timing of the disbursement must be in the same calendar year (not academic year) in which payment is due. So for instance if spring semester tuition + fees are received in December, then we should wait until January to release payment. Is this correct? Or am I misunderstanding.
I’ll be curious to read other comments but can share what we are doing. We talked to our financial guy and he said we can pay ourselves from the 529 and then pay the school without any penalty. We just need to keep the bursar bills to prove that the balances match. We opted to do this to avoid potentially having a delay from our 529 paying the school (it’s a control thing for my husband).
My daughter is intending to go to grad school so any extra $ will go towards that. I would think intuitively that taking the interest hit is not a good idea and to keep the money in the account.
Again, interested in what others have to say that have more information.
I’ll take the easy Q first (#3).
I think the deal is, the withdrawal from the account should be in the same tax year you make the payment to the school. Honestly, that’s just based on what I’ve read on cc. I guess it’s so that you have a payment record or receipts that equal the dollar amount on the 1099 you will get at the end of the year.
So it’s fine to make a payment in Dec for spring term. Be sure to download and read irs Pub 970. I think it addresses this concern.
Re #2, if there’s a chance of grad school, I don’t know why someone would recommend zeroing out the account earlier. At any point in time, if you end up taking excess money out, you will pay the penalty and also owe taxes on just the earnings portion. No sense doing it prematurely unless your tax bracket is changing drastically.
There’s an exception or two to the penalty. Again, check Pub 970.
Re #1, I think the cleanest way is have funds sent straight to the college. 2nd best, you pay the school and reimburse yourself from the fund (in the same tax year).
I’m not sure method of payment affects possible taxation (as in, who pays the tax), which you should be trying to avoid anyway, so no point involving your son in the transaction. Pub 970 gives some examples of having to pay taxes on excess withdrawals.