<p>Thanks for posting, and saving others from making the same mistakes.</p>
<p>It makes me appreciate more the Private College 529 Plan that someone else mentioned upthread, where we’re protected from tuition increases, and with the tax advantages.</p>
<p>The Private College 529 Plan is great if your kid ends up going to one of their member colleges, but not as great if they don’t. I hedged my bets by putting money for Kid #1 in the Private College 529 Plan and for Kid #2 in a regular 529 Plan. Money is transferable to family members, so I just needed one of the two kids to end up at one of the private member colleges for it to work out well, and Kid #1 is now a freshman at a member college. </p>
<p>I might have made the exact same mistake the OP did with the regular 529 plan money for Kid #2. It seems like a problem with the tax code, that I wouldn’t have guessed existed.</p>
<p>I may have already made this rant, but because I’m paying up the wah-zoo, I get to make it again:</p>
<p>I don’t know if it’s the whole “college system”, or if it’s the IRS, but whatever it is, I’m tired of being penalized for having the foresight to save for my kids’ education.</p>
<p>We have too much money to get need-based aid…we knew it all along, and that’s why we saved all these years!! And the thanks we got was getting slapped with an unexpected tax bill, **because of **the lifetime savings.</p>
<p>Sometimes I understand how people go postal. :eek:</p>
<p>Knock on wood, we don’t have cancer nor any other horrible disease, and nobody’s dying. Our kids go to great schools, they’re happy, and college is pretty much paid for. I’m just going to keep reading this last paragraph…</p>
<p>This points out again how unbelievably complex the tax code is when it comes to education. Publication 970 is about 100 pages long. Every benefit has a different income range at which the benefit phases out. Sometimes, the calculation of “income” differs (we really need to modify the AGI by adding back in some exclusions?). Benefits have different rules relative to allowable expenses. Some just tuition/fees. Others allow room/board, etc. It all gets pretty crazy. Then, as vballmom points out, and OP is living thru, we have to play timing games to match everything up. My favorite(?) examples of the complexity are Figure 2-1 (a flow chart with 12 decision points to determine if you can take the Opportunity Credit) and Appendix B which provides a summary of all the criteria and rules for each benefit.</p>
<p>A very timely thread-- so sorry, heyalb, that you’ve had to go through this, but we appreciate your generosity in sharing so we can learn. I was considering the prepayment option if my D chooses a school that offers it (one of her finalists does). I just assumed it would be considered tuition paid in one year.</p>
<p>Only two of her three finalists are in the Private College 529 plan, so I’m spooked to do that, but will check to see if the third is considering joining.</p>
<p>I didn’t know you can transfer from siblings! That could really help us. Older D had a smaller 529, since we had less time to save, and hers will not make it through senior year. If D2 goes to the Good Scholarship School, maybe we can transfer some of her funds to cover her big sister’s… and make it up to her later.</p>
<p>Considering that schools have been upping COA 5% a year, maybe you’ll come out better by prepaying anyway.</p>
<p>Still, I don’t like being blindsided by a tax bill. I think that the IRS should put heyalb’s example in their little tax booklet to give parents a heads up. Then you can weigh the pros and cons of prepaying tuition. </p>
<p>And the 529 people should be a little more upfront about the problem that you’ll run into. I know that they are not tax advisors, but my brokerage always sends little tax write ups and then tells me to consult my tax advisor.</p>
<p>I agree ellemenope, heyalb’s assumption was perfectly natural! He was paying out all that money in the same calendar year, directly to a college for educational expenses. I would have made the same mistake (if we had enough money in a 529 to pre-pay 4 years, that is).</p>
<p>Another question is how is the gain calculated. Is it prorated based on portion that is over the amount paid in that year? For example, if OP made 40k gain when she paid all 4 years in that first year, is the gain 30k?</p>
<p>“I have consulted with a professional. About the only thing I can do is to try and get the remaining two years of tuition/room/board back from the school, re-deposit it back in the 529, and re-file taxes. At that point, the college would, no doubt, hike the tuition/room/board for my son’s final two years there.”</p>
<p>Also if above is true, then what would stop you from depositing your own money into the 529? I am also assuming that the school presumably will issue 1099 every year for the proper amount you paid divided by 4. If not, when do they issue 1099 for the rest of the money you paid? It is a little out of whack but if you take your own money out of 529 every year and get a matching 1099 from the school, then technically everything should jive?</p>
<p>Nothing, if I’m reading you correctly. But then you’d be unable to show that the school paid it back. Am I reading you correctly?</p>
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<p>Yes they do. But everything does not jibe, because in the “divide by 4” scenario, you don’t have to pay taxes on any gains. In my scenario, it is all considered gains because it was indeed cashed out in one year.</p>
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<p>It’s difficult to tell, exactly. My accountant is working on it. The IRS doesn’t give you much time, however. I got the notice a week ago, and the payment (or excuse) is due in another week. For an accountant to do a good job (during 2010 tax season, no less), s/he needs a little more time.</p>
<p>It seems to me that the OP should contact their congressman… if there are a lot of colleges with the pre-pay-all-four-years option, then the 529 withdrawal rules need to be amended. 529’s are designed to help you save for college, so if the funds are used for college it stands to reason that any college withdrawals should be tax-free, regardless of if they’re used to pre-pay. I’m betting this is something no one thought of when the original 529 law was written, and I think it needs to be amended. It wouldn’t help the OP now, but it might help others in the future.</p>
<p>In the mean time, when investing in a 529, the company providing the 529 (mutual fund company or whoever) should make it very clear in their publications what the limitations are for withdrawals - only payments made to the college in the same calendar year are tax-free. (BTW, I believe it’s the year you send the payment that counts, as long as the semester or courses begin with 180 days of the payment being sent or something like that. I know that when I withdrew in December to pay for a semester that started in January, it was not a problem for my previous year’s taxes.)</p>
<p>I looked into the Private College 529 plan, and that won’t solve the prepay problem either, at least for us. Although it appears to allow you to prepay in a way that the IRS will allow, the “coupons” that you buy have to be held for 36 months before being used. We’ll be writing the first tuition check for D2 this summer. So much for that idea.</p>
<p>I have no expertise at all on this subject but - </p>
<p>When you prepay the 4 years and then the student withdraws after the first year, what happens to the remaining 3 years worth of payments? Does the college keep it? If so then why wouldn’t the entire amount be considered as qualified expenses in that first year? Qualified expenses simply means what’s paid to the college doesn’t it? Even if one gets some kind of refund if the student withdraws it seems that since the money has all been paid up front to the college for college expenses it should all qualify at the time it was given to them. Given that, maybe another angle on this, which might be more flexible than the IRS, would be to have the college indicate the full amount in the current qualified expenses form rather than showing only a quarter of what you paid them. If they did that then it seems everyone would be happy and it would actually match what was done as opposed to the way it is now where you’re being unfairly (IMO) gouged by the IRS for this.</p>
<p>researching4emb you’re correct, you can’t prepay all 4 years, but you can prepay your D’s senior year. Depending on your expectations for inflation and the rate of return on your 529, you might still be ahead to move 1 year’s worth of tuition into the Private College 529 plan. The rate of return for an age-based 529 is going to be relatively low because most of the assets are in cash (1% return). So if fees are increasing by 5%, compounded, it might still be a good investment.</p>
<p>I think the point the OP raised is important and any college that has a prepay plan should make sure they’re very explicit in informing the payer of this IRS consequence - not just the “consult your accountant” catch-all.</p>
<p>I think at most colleges with these plans, if your kid withdraws you get back what you paid for the unused semesters, but no interest or earnings. But I could be wrong, there could be a penalty. </p>
<p>I agree that colleges with these pre-payment plans should point out the 529 tax withdrawal implications in big red letters when offering this option to parents!</p>
<p>“Nothing, if I’m reading you correctly. But then you’d be unable to show that the school paid it back. Am I reading you correctly?”</p>
<p>No I don’t think you understand my point. I was responding to this statement made by you:</p>
<p>“I have consulted with a professional. About the only thing I can do is to try and get the remaining two years of tuition/room/board back from the school, re-deposit it back in the 529, and re-file taxes. At that point, the college would, no doubt, hike the tuition/room/board for my son’s final two years there.”</p>
<p>If what your professional may have said is true, which is you can get the money back from the school and deposit it back into 529 and refile tax. Then my point is that, don’t bother getting the money from the school, deposit your own money into 529, refile tax and everything might be alright. You still are prepaying for 4 years, the college should issue 1099 every year for the 1/4 the original amount, otherwise how would they issue 1099 anyway with the current arrangement? Then you withdraw from 529, every year like you would paying year by year. You need to check with the school that 1099 would be issue yearly in this case. I am assuming that the rubber meets the road where 1099 is matched up with 529 withdrawal.</p>