Hello,
I’ve seen a tiny bit of similar discussion and I’m looking for help/advice/anything.
We started a 529 plan 16 years ago with the idea that it could be used for our kids education at ANY accredited university/college. At the time we lived in the Netherlands and all major universities in the NL were ‘accredited.’ Now the rules are different, it seems. And many Universities (non-US) don’t want to bother with the paperwork necessary to be considered “eligible” OR “accredited” in the US.
So it looks like we may be paying for University with a penalty on our 529 funds. But how does that work? Do I have to make sure that all expenditures are “qualified” even though the school may not be? Or can I basically withdraw the funds with the same penalty no matter what we spend the money on?
Also, if anyone has experience of a similar nature…please let me know your story.
I don’t think the IRS rules about colleges outside the United States being Eligible Educational Institutions for 529 purposes has ever changed. Here’s what the IRS says:
Eligible postsecondary school. An eligible postsecondary school is generally any accredited public, nonprofit, or proprietary (privately owned profit-making) college, university, vocational school, or other postsecondary educational institution. Also, the institution must be eligible to participate in a student aid program administered by the U.S. Department of Education. Virtually all accredited postsecondary institutions meet this definition. The educational institution should be able to tell you if it’s an eligible educational institution.
An eligible educational institution also includes certain educational institutions located outside the United States that are eligible to participate in a student aid program administered by the U.S. Department of Education.
The main criteria for overseas colleges is that the school must be eligible to participate in a student aid program administered by the U.S. Dept. of Education. As far as I know, this has always been the case. Contact schools the student is interested in and ask if the school is eligible to participate.
If an overseas college isn’t eligible as described above, it doesn’t matter if the expense would otherwise be considered “qualified.” The earnings portion of any 529 distribution used for expenses at a school that is not 529 eligible would be subject to U.S. income tax and the 10% additional tax (penalty) as well.
“The main criteria for overseas colleges is that the school must be eligible to participate in a student aid program administered by the U.S. Dept. of Education. As far as I know, this has always been the case. Contact schools the student is interested in and ask if the school is eligible to participate.”
Well, since this is now a serious topic for us, I looked up the 2005 code and you are absolutely right. Back then, I looked it up following links from the 529 program and savingforcollege to arrive at a confirmation that it would work. The point for me is that I didn’t realize at the time that colleges had to make an effort to stay eligible other than maintaining their accreditation. NOTE: the university my son wants to go to is one of the top technical schools in Europe, so I have no doubts about its credentials…but the DoEd recognition is another thing.
“If an overseas college isn’t eligible as described above, it doesn’t matter if the expense would otherwise be considered “qualified.” The earnings portion of any 529 distribution used for expenses at a school that is not 529 eligible would be subject to U.S. income tax and the 10% additional tax (penalty) as well.”
I understand that it would be subject to taxation then…but why would that not be capital gains tax instead of income tax? Also, am I right to recognize that if I pay the tax and penalty, I could use that money for anything else? since I’m just withdrawing against the rules anyway.
Also, does anyone have experience with how to get a university added to the list? Is it really a lot of work for the university, or is that just supposition?
The entire withdrawal is taxed as income (because it was put into a tax advantaged vehicle), while only the gains incur the 10% penalty. At that point, you can use the funds for anything, doesn’t have to be QEE.
Taxable 529 earnings are always taxed as ordinary income, and not as capital gains. That’s just the way it is. And yes, you can use 529 money for anything you want, as long as you are willing to take the tax and penalty hit.
I don’t know how much work it is, but the school must take action to be placed on the Dept. of Education’s eligible list. If the school isn’t already eligible, you can always ask them to take the necessary steps to become eligible. The worst that can happen is that you are told “no.”
Unless I’ve completely missed something over the last 20+ years, 529 contributions have never been a US Federal tax deduction. The amount contributed is not taxable on withdrawal, as it was funded with post tax earnings.
Although Section 529 contributions are tax-exempt, they are not tax-deductible on your federal income tax return .
the earnings portion of a non-qualified 529 plan distribution is subject to income tax and a 10% penalty.
Some states allow deductibility, so state taxes would need to be paid on the original contribution amount.
I’m going to hazard a guess that staying on a DOE list requires an investment of time and staff. I don’t have experience with this specific topic, but universities in the US which get federal funds (either financial aid, research grants, etc) need entire departments to make sure they are in compliance. So it may well not be worth it to a university overseas to jump through hoops for the sake of 5 kids a year? 3? That might be impacted.
Always worth asking the question though-- and if you have mentally “spent” this money on your kids education, it might be worth just biting the bullet on the taxes and penalty to have the cash available for its stated purpose. I know people who have spent down their kids 529 on a home remodel for example (reasoning that with the penalty it’s still cheaper than credit card debt if it takes ten years to pay that off) which I think is nuts (but it’s not my money). At least your kid will come out of this with a college degree and not just high end appliances and Italian tile!!!
This is not correct. As RichInPitt correctly points out, 529 contributions are made on an after-tax basis at the federal level, and only the earnings portion of a non-qualified distribution is subject to federal taxation as ordinary income plus a 10% “penalty,” unless an exception to the penalty applies. Treatment for state tax purposes is a completely different discussion, and of course will depend on the state or states involved.
Yes, I wasn’t clear. The tax advantage is that earnings grow tax free, and yes, as you say some states offer state income tax deductions for certain 529 plans.
Remember that you can choose who to distribute the funds to, it could be you or the beneficiary, which will affect who pays the taxes. Of course if your child receives the proceeds then kiddie taxes may need to be considered as well.
You also might be able to get the school to give you a 10% scholarship to make up for the fact that their failure to remain accredited is increasing the financial burden on you.
There is no indication that there was a “failure to remain accredited” by a school. OP in his first post was mixing up some of the terms used regarding the eligibility of overseas schools to be qualified educational institutions for 529 purposes. If there are a whole bunch of hoops for overseas schools to jump through to be 529 eligible, and very little benefit for the school, it’s perfectly understandable why a school might let an eligibility status lapse (and it’s not clear that any schools OP’s student is interested in were even previously eligible).
I assume you’ve already checked the list, but just in case, there is a link included in this article: Federal Student Aid
When we looked at overseas schools, I guess we were just lucky, as they were all on the list.
Please forgive my ignorance and for piggy backing on this post, but if my son stays home bc of all online classes/Covid, can I use 529 funds to pay for his “room and board”?