Would moving the funds of a 529 account where my child is the beneficiary to a 529 account where my child is the owner lower the total taxes paid on the gains of the amount withdrawn? My child will be a senior and for senior year the majority of college expenses will be paid for by a scholarship. No need based aid will be forthcoming. The remaining part of the college costs will be paid for out of a 529 account. Since a good part of the 529 account are gains we will face a decent tax bill come tax time, for this reason I thought we could minimize taxes paid by making my child the owner of the account balance since then the resulting 1099-Q would now be applied to my child’s tax return and possibly(?) taxed at a lower rate.
Does the above make tax sense?
You pay tax on the gain when withdrawn from the plan. You receive a 1099-Q containing the taxable amount. I think that is the way it appears on my tax return.
I had a long chat with Fidelity’s 529 dept about this. My older son will have remaining funds in the account where he is beneficiary (I am owner). You can withdraw funds from the 529 for the scholarship amount with no penalty but taxes on gains (as you know). The only scenario where there is no penalty and definitely no tax is if the withdrawals are for qualified expenses. We will be in a similar situation and plan to withdraw the remaining funds and set up a new account (non 529). I was told that if I transfer 529 ownership to him there might be tax on the gains but that the law was unclear. Fidelity advises clients to expect to pay that tax but is aware many don’t. If your child is not certain about continuing education in grad school, you may want to take advantage of the no penalty but some tax scholarship out. In our case it is better to withdraw to him rather than ourselves bc his tax will be lower. I ran some numbers with an online tax calculator to figure out most economical route.
The other option is to keep it in the account and assign one of his children as a beneficiary someday.
This obviously doesn’t work if you need the money, but if it was intended to be used for education, financial planning shouldn’t have counted on it.
You effectively pass it on to him as an inheritance - he doesn’t need to save for/invest post-tax money in a 529 himself - without ever paying taxes on the earnings.
After checking my tax return for 2019 the 529 withdrawal (1099-Q) was not handled properly! The gains should be tax-free when the withdrawal and usage of the funds, for qualified expenses, occur in the same tax year.
I used TurboTax for 2019 and in their support documentation this issue is addressed and a workaround is prescribed. AFAIK why the addition of a 1099-Q in TT would result in a taxable event had to do with the the order the 1098-T and 1099-Q were added to the return.
The good news is, after amending my 2019 return, with the support of TT, I am expecting a refund of ~$5k!
Hi, @kmrcollege! We are in the process of doing exactly what you described and my understanding matches yours. I opened a second 529 account with our daughter as the owner. I am moving the funds from the account where I am the owner and she is the beneficiary to the account she owns. The dollar value of scholarships can be withdrawn and only be subject to taxes on the gains. Paying tax at my daughterś rate is more favorable than paying at mine. One thing that isn’t clear to me is if the related scholarship withdrawals need to happen within a certain time frame. Could we just wait until we know if she will be going on for further degrees and, if not, withdraw the funds even if it is after graduation?
Hi @WImom94 - I am sure others on this thread can provide a more professional answer but as long as the withdrawal occurs in the same year as the qualified expense there is no tax due.
If one child finishes with money left in their 529 you can also transfer it to a different child’s 529 (for example if the other child is the one who will need to pay for graduate school).
My understanding is that as long as graduate school (or medical school or veterinary school) is expensive enough to use up what is left in the 529 fund, you will not end up paying any tax as you take the money out of the 529s.