Hi, I have been lucky that my parents have saved enough money to pay for my tuition for my undergraduate education. However, I have a couple of questions regarding on what happens after schooling if the money were to be transferred to me. I would have attended a University of California school, but instead, I chose a lesser expensive, regional university, which means that there will be quite a bit of money left over in the account. Since my parents saved tuition for both my sister and I, I wanted to know how I would be taxed if the 529 plan were to be transferred into my name, or if my parents would take the money out and then help me start out and get a leg up on life.
Sorry if I sound pretentious, but I am trying to prepare and see what will happen in the future with my finances after college.
Check on what the money can be used for in addition to tuition. Find out which school related expenses can be covered. Also figure out if a masters in your field is in your future.
Basically yes, if you withdraw the money for something other than an educational expense (and there is a list of what qualifies including tuition, room and board, books, computers) there is a tax. There are lots of things that can done to avoid that tax - use it for grad school, transfer it to your sister, save it for your own children.
We still have some funds in a 529 plan for our younger d who graduated in 2010. As in the performing arts, she may never attend grad school but hasn’t ruled it out yet. Hasn’t happened yet but if/when the situation arises we will investigate transferring to a 529 for grandchild.
In general, tax wise, it would be unwise for your parents to transfer it to you directly. They can keep in in a 529 for you until you are 35. Or they can move it to an account for any other child or grandchild. Let’s say you have a kid when you are 33, how great would it be to already have an account started for them? Or for your sibling’s children?
Why is that? Not all 529 plans allow a change of ownership, but for those that do, the act of a parent transferring ownership to a child should have no tax implications.
Where are you getting the age 35 limit from? Not from the IRS.
Have you discussed this yet with your parents? Here’s my thinking as a parent. The extra money saved is mine, in my name, with flexibility to assign beneficiaries. I have even taken some money from their designations to move to my own 529 when I was in grad school. Right now, my older son has graduated and there is $3000 left over. I am just keeping it there in case he decides to go to grad school, or I may transfer it to his brother, who by virtue of being younger and with college costs rising, may need it. If neither child ends up needing any leftovers, I might name my niece as the beneficiary. Or,I may take the 10% tax penalty on earnings and move it to our retirement account, which is where it would have been had we not been putting it into 529s. I guess unless your parents explicitly told you any leftovers are there for you to keep, don’t be too presumptuous that it is yours.
Sorry age 35 was proposed but never went through and it stuck in my head.
As above poster said the money belongs to the parents. They can use for future ed. costs of any family members, personally I plan to save any leftovers for grandchildren should there be any.
Yes, I agree that if the parent is the account owner the money belongs to the parent. But if the parent decides to transfer ownership of the account to the child/beneficiary (if the plan allows transfers of ownership), there shouldn’t be any tax consequences.
Possibly, if the account is liquidated and the money is not used for qualified education expenses. It depends on a number of factors, including (but not limited to) the amount of account earnings at the time of liquidation, the child’s tax bracket and other taxable income, and the amount (if any) of scholarships that the student received that have not already been offset by non-QEE distributions.
Some of the tax consequences for unqualified withdrawals depend on the state you live in /state 529 plan is in. I live in New York, which gives a tax deduction for 529 contributions but that gets “clawed back” if the contributed $ isn’t spent on qualified expenses. One of my kids had a few thousand left over after college in a 529 account of which I was the owner and had no plans for grad school. I distributed the $ to her and paid the New York “clawback” and she paid the tax and penalty on the interest portion of the distribution. Because she graduated in May she was only working half the year so her tax rate was low. If you think grad school is a possibility, definitely leave the $ in the 529 until you know for sure.
Some of the above responses mistakenly think that money in a Section 529 Plan naming the parent as the ACCOUNT owner is still an asset of the parent’s. In the eyes of the IRS the money is that of the child/beneficiary.
In fact, the money placed into a 529 in the name of a child as beneficiary is considered to be a completed gift. That is one reason why a wealthy parent might consider placing $70,000 – all in one year – into a child’s 529 (two parents together could gift $140,000). Then they file a gift tax return with their Form 1040 each of the next 5 years, noting each year that the allowed $14,000 maximum of tax-free gift was given and spread over those 5 years. This gifting – which removes the money for one’s estate – is sometimes a motivation for older relatives/grandparents to contribute to a 529, although a pro-rated value of that full gift amount is clawed back into the estate for estate-tax purposes only, if that individual dies prior to the passing of a full 5 years.
Yes, the 529 is a rare beast: You have made a completed gift and yet retain control of the account.
Interesting @MinnesotaDadof3 Yes, I am aware that contributions to the 529 are subject to the gift limit of $14k per year ($28k for two parents) before a gift tax return needs to be filed. However, if the parent account owner liquidated the account and did not use it for qualified expenses, wouldn’t he or she pay tax on the earnings at their own rate, not the child’s?
Also, in my state, Massachusetts, I don’t think I am allowed to transfer ownership.
(As a side note, I am being educated on Minnesota estate tax details since losing my dad earlier this year.)
As you say, 529 accounts are a rare beast: money in the account is considered to be a completed gift to the beneficiary, even though a gift giver who is also the account owner has not given up control of the money. You are right about the money being removed from the account owner’s taxable estate (with the exception of a death that occurs before the end of a 5 year gift election). However, the account owner could always change the beneficiary to himself and take a non-qualified distribution. In that case, in the eyes of the IRS, this is potentially a taxable distribution to the parent/account owner. And even if the child remains the beneficiary, a distribution that is made payable to the parent/account owner (as opposed to the student/beneficiary or the school) could be looked at by the IRS as a taxable event for the parent. So no, in the eyes of the IRS, the money is not always that of the child/beneficiary.
Also, it’s important to point out that for federal financial aid purposes, money in a parent-owned 529 account is never considered a student asset.
Thanks @belknappoint So in my state where I cannot transfer ownership of the account, I could request issue of a check to my son and then it would be taxed at his rate on the earnings (on, say, $1000 of the $3000) plus a 10% penalty.
If his rate is 25% tax bracket, that would mean he would pocket according to this formula: $3000 - $10000.25(his federal tax rate) -$10000.10(penalty for non-qualified withdrawl) = $2650? (Minus state tax which I did not include)
I’m giving the example partly for self edification and also in case it helps the original poster.
I did some reading which said that if a parent takes money out of the 529 that is not used for qualified college expenses, they will incur taxes and a penalty (same as if you take money out of a 401k early), but there might not be a penalty if the parent is over 59 1/2.