529 owned by a grandparent..does the beneficiary child have any "rights" to the money?

If a grandparent starts a 529 for their grandchild, does that child have any rights to the money? Or, can the grandparent take the money out of the account for non-educational expenses, pay the penalty and keep the balance?

The owner of the 529 can do whatever they please with the money. Yes, Grandparent can take back the money. Federal tax is owed for any earnings and recapture needed for any state tax deductions taken. There is also a 10% penalty, I believe, on the gains, if any.

I expected as much, thank you for confirming.

Are federal and state taxes taken immediately (is this part of the “penalty”) or paid later?

You get a 1099Q when you withdraw funds from a 529. You use the information on there to report any taxable parts of the withdrawal.

Forgive my ignorance: does that mean the owner can withdraw the FULL amount of the 529 for non-educational expenses and will only pay the penalty (tax) when filing their taxes next year?

Yes. Unless the custodian (financial institution) has something written into the rules of the plan. [I know that with my plan there is a question on withdrawals about whether the withdrawal is for qualified educational expenses or not. I do not know if they would withhold taxes - or ask if withholding taxes is desired by the plan owner.]. Check your plan documents.

Because there are many 529 plans in the many states, it is possible that there are some rules that an individual plan may have. I can tell you that in the two states where I have had 529s, one can withdraw the money and do as one pleases with it. The withdraws amount is reported on the 1099Q the following year with a breakdown between earnings and principle. If the withdrawal were used for qualified education expenses, you do nothing in terms of reporting the withdrawal on tax forms . If, not, you are supposed to report the earnings portion of the withdrawal as reported in the 1099Q on the federal 1040. States vary as to how this is reported. If you got a state tax deduction when you made the contribution to the 529, you are often required to recapture that deduction and there may be additional penalties involved.

You can change the beneficiary of a 529 you own as long as the new beneficiary meets certain relationship requirements. Grandma’s 529 is her asset, not the beneficiary’s, until she turns the money over to said beneficiary or the beneficiary School or loans. Not reportable on FAFSA or PROFILE as a student or parental asset because it is not and is possible that the money in the account does not go towards said student’s expenses. There is no obligation in part of grandma to use those funds that way. She can change her mind.

Although it may vary by jurisdiction & issuer, flexibility is needed in case the intended beneficiary decides not to attend college or if the intended beneficiary wins a full ride scholarship or otherwise fails to use all of the 529 funds for qualified educational expenses.

P.S. Issues to consider: Whether or not a 529 plan is irrevocable and whether or not the owner can change beneficiaries.

That is incorrect. You can take the money out without any withholding, HOWEVER, any gains are taxable at regular income tax rates, on top of the 10% penalty. So you don’t pay when you make the withdrawal, but come April 15, you do have to pay taxes on any gains. That is also when you pay the penalty I believe.

Best course of action would be that you and your child do nothing to upset grandma, unless that boat has already sailed.

Best answer ^!

Unfortunately, things are a bit more complicated. Grandma passed years ago, and Grandpa’s new wife wants him to withdraw the money for themselves, take the penalty. She/they are completely irresponsible with money, and I’m also worried whatever they do will come back to bite them next April 15, unless all penalties are paid upfront when emptying the fund for non-educational expenses.

Money aside, it’s a gut punch because this is money deceased Grandma specifically put away for kiddo’s education; Grandpa/new wife have not contributed to the fund since Grandma died.

Sad to hear that. Is grandpa that gutless or in the thrall of his new wife? That is a rhetorical question.

Grandma being your MIL, I assume, so your DH isn’t having a discussion about this with his dad?

Income tax and any penalty owed on the earnings portion of a non-qualified distribution are not paid upfront. The 529 administrator is not responsible for determining what is and is not a qualified distribution.

No, my father. And my mother who passed away when kiddo was 5 years old.

I did have a discussion with my father, and was very clear in NOT giving him my blessing, but legally he is the owner of the 529, and I cannot control what he does.

My father is financially in a very bad place (completely irresponsible spending) compared to myself/dh. We are not rich, but we are smart about living below our means.

TomSrOf Boston is on point.

Hmmm. My father told me $X is in the account, and if he takes the money for himself instead of using on my child’s education, he would be able to take home $Y after $Z penalties. Does this sound like he’s accounted for any tax hits? On top of everything else, I don’t want him to have an unexpected bill due April 15.

I’m very sorry for your situation. That is just terrible!

It’s hard to know what he has or has not accounted for without hearing from your father. If he empties the 529 for his own use, he should do a back-of-the-envelope calculation to figure out how much he needs to hold on to for tax time, based on the amount that is attributable to earnings and what his marginal tax rate is expected to be. And don’t forget the 10% “additional tax” (penalty). For instance, if there is $100k in the 529 account, $30k of which is earnings, and your father takes the whole amount this year for his own (non-qualified) use, and further assuming his total 2020 taxable income with the 529 earnings included puts him in the 22% tax bracket, he should expect to pay an extra $6,600 in income tax plus $3,000 in “additional tax,” for a total of $9,600.

Thank you @BelknapPoint . I doubt my father has a clear picture of what he’s in for this coming tax season, due to other complicating events (he completely emptied his retirement account this year.) I hope he has a CPA who can advise him what to expect. I will strongly suggest he consult one before draining the 529.

The grandparent 529 would have covered one year of room & board, that’s it. It’s really more of a gut punch than the money, because my mother (and father at the time) wanted to help pay for my child’s education. Dad/wife haven’t added a penny to the account since my mom died.

My father “generously” offered a possible solution of signing the 529 over to me, if I write him a check for the amount he would take home after penalties. That way nothing gets lost to penalties and at least a fraction (less than 50%) goes towards educational expenses.

My gut says I should walk away. I do not want any strings attached to this toxic transaction. He needs the money more than I do. But I also feel as though I’m dishonoring my mother by not making use of some of the money she carefully put aside for her grandchild.

Since you said the amount would only cover about a year of room and board I’m assuming the total amount is around 10K? If so his deal doesn’t seem all that generous. I don’t know what the earnings are of course, but going by both of my kids accounts that are each sitting at about 30% earnings, if his account is about the same that would mean he’d only be paying taxes and penalties on 3K, so you’d have what? $1000 after cutting him the check. I mean, I guess I’d do it because $1000 is still a large amount of money to me, but I don’t think you’ll be getting anywhere near 50%.