529 Plan

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Greystone412

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May 27, 2021
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My understanding is my son will get an interest free loan during Swab summer or soon after for uniforms. Does anyone know if you can or has anyone used their 529 to repay the loan. He was just admitted last week and has not received any paperwork yet. I'm scrambling to learn as much as possible within the next month. Thank you.
 
Yes. Here is a link with more info.

Note that the loan only covers the cost of items up through sometime midway through the fall semester. After that, the cadets still have to pay for the books for the rest of their time at the Academy along with other uniforms they are issued after that first semester. But the loan covers the bulk of the up-front costs.
 
Once my cadet got his loan amount details we had the check sent directly from the 529 to the Academy (right around the beginning of spring semester).
 
You should check with your tax accountant to make sure you can do this.
 
The tax code allows withdrawals from 529s with no penalty for those attending Service Academies (there may be an amount limit you can withdraw though). You will have to pay income tax on the withdrawal (but no penalty is applied). The withdrawal can be used for ANY legal purpose. If the loan is zero interest, you may not want to pay it back quickly. I have done these 529 withdrawals for the last two tax years for my MIDN who is at the USNA. The Turbotax software I used addressed the 529 withdrawals for those attending a service academy. In stead of paying back his zero interest loan, we funded a Roth IRA for him. Midshipman are employed by the USN and their "earned income" allows them to open a Roth IRA for up to $6,000. This puts them ahead for retirement savings. Time Value of Money ... will make a noticeable difference.
 
My thought is that we posters on this forum don't have to worry about going over the 11M federal estate tax exemption. That would be considered a good problem!!
But how about entering into a higher tax bracket by a few $$$? You could give that extra $$$ to Uncle Sam, or to charity... or to a relative's 529 Plan. Bottom line, you're not keeping it; you just have to choose which bucket you're going to put in in. This might be a bucket you've not considered.
 
529s for Academy expenses is a complex area. Some have used them to pay USCGA expenses. However, cadets are not considered full time students by the IRS, they are active duty soldiers. As such, the academy does not issue 1099 forms for college expenses like civilian schools do. 1099s are needed to justify TAX FREE 529 draws on the tax return. But, because they are not college students, after their first year they do qualify for the savers credit which is a valuable tax credit.

The bottom line is with the IRS you can either be a active duty soldier or full time student, not both. There are different rules for each.

West Point has issued guidance that cadets are not to file as full time college students, providing at least one precedent on this complex matter.

@Don't Give Up the Ship gives an IRS accepted option to get your 529 funds out. As he says the 10% penalty is waived for academy kids. I would recommend an enhancement: as he describes if your cadet uses his pay to fund a Roth IRA (a very good idea), then that will make them eligible for the savers credit, and since they make about 13k a year as a cadet, the IRS credit is more than their tax. That extra credit can be used to cover the taxes due on 529 withdrawals. Careful planning is required but spreading the 529 non-qualified (taxable) withdrawals over 3 low earning academy years can lead to significant tax saving.

Great info from @Don't Give Up the Ship .

A final FYI, USCGA will does several small loans as gear, laptops, etc. are issue, so it is kind of an ongoing process. Cadets only are required to buy books from the cadet store their first year. After that they can use Amazon or whatever saving significant funds.

Best to check with a tax accountant.
 
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Haveaniceday said:
529s for Academy expenses is a complex area. Some have used them to pay USCGA expenses. However, cadets are not considered full time students by the IRS, they are active duty soldiers. As such, the academy does not issue 1099 forms for college expenses like civilian schools do. 1099s are needed to justify 529 draws on the tax return. But, because they are not college students, after their first year they do qualify for the savers credit which is a valuable tax credit.

The bottom line is with the IRS you can either be a active duty soldier or full time student, not both. There are different rules for each.

West Point has issued guidance that cadets are not to file as full time college students, providing at least one precedent on this complex matter.

Best to check with a tax accountant.
Click to expand...
I guess it might vary per state, but in most states a 1099 is not required to get a distribution from your 529. As long as you keep receipts and are prepared to show that the money was used for school expenses, it is fine.

Also, someone mentioned above that you have to pay income taxes on the withdrawal (but no penalty if you are at a service academy or have scholarships at a civilian school). This is not quite true (at least in my state). You don't have to pay taxes on any portion used for school expenses which can include required expenses like uniforms and books. For any additional withdrawals, you only pay taxes on the earnings portion of the withdrawal.
 
To clarify, I am only describing federal taxes, state taxes vary to much to describe here.

Also, since cadets are active duty soldiers, there is no allowable college expenses, as they are not in college, they are in the military in the eyes of the IRS. As I described it is a complex area of tax law with many misunderstanding.

As an additional example, the savers credit is not allowed for full time students, so if your cadet reports on his tax return that he is a college student, he will not be eligible for the tax credit.

The IRS will apply the rules based on what your cadet files on his taxes. They receive training at USCGA before taxes are due how to fill out the forms and state their employment as active duty military, not college student.

529s are only eligible for qualified (non-taxed) withdrawals for college students. Since cadets are not college students, all 529s withdrawals are designated non-qualified (taxable for federal taxes). So, the best thing you can do is work to minimize the taxes due, and this can be done as described by opening a IRA and claiming the savers credit to offset the federal taxes owed.

The 10% penalty on non-qualified withdrawals is waived for service academy attendance.

Federal taxes are only paid on the gains (earnings) in your account, not your deposits.

Hope this helps explain your options.
 
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Here in New York, NYS-specific 529 plans qualify for a state deduction for residents while 529 plans from other states do not. My kid's plans are from another state because when they were opened, NYS did not have a 529 plan. So yes you can open a 529 plan from anywhere, but the tax exemption/deduction may be state specific in your state as it is in the 'King Cuomo' state.
 
Service Academy cadets are not active duty. See 38 U.S.C 3002 (6) (b).
It appears that a good approach would be to pay the qualified expense to the Service Academy for education expense for the year from the 529 plan for three years and take enough out each year to pay taxes and contribute to his/her Roth IRA.
 
As you point out there are various United States Code cites that conflict. For example 38 USC 1965 (1) (d) states cadets are active duty. I would not bet the farm in an IRS audit on the one USC cite you refer to. Guidance from the academies such as the letters from a JAG officer in 2021 attached below, I would consider to be controlling on this matter.

As I have referred to earlier, there are no "qualified educational expense" at a military academy, as they are not considered to be educational institutions by the Dept. of Education. Thus, the Academy will not issue you a IRS form 1098-T for education expenses.

You can make non-qualified withdrawals from your 529 for any reason and pay the appropriate tax. I recommend you have any non-qualified draw from a 529 be paid to the cadet and their SSN, as they will likely be in a lower tax bracket than the parent.

Recommend you consult a CPA if you wish to pursue "qualified expenses" from a military academy as that position is not supported by the attachments below.

Attached are source documents published by USMA that explain the correct status and tax situation for Cadets you may find helpful:

Good luck!
 

Attachments

  • USMA Tax Letter 2021.pdf
    144.5 KB · Views: 28
  • USMA Tax Tips for Parents 2021.pdf
    246.2 KB · Views: 31
Here’s a good general reference (2021) from the Congressional Research Service on cadet and midshipman status, from a generally reliable source.


It cites the definitions in U.S.C. 10

www.law.cornell.edu

10 U.S. Code § 101 - Definitions

www.law.cornell.edu www.law.cornell.edu

That does seem to conflict with the other citation, but I would lean toward the “walks like a duck, quacks like a duck” school of thought. Setting USMMA aside, the cadets and midshipmen are 24/7 subject to lawful orders, the UCMJ, their CAC cards are presumably coded that way, and they are treated that way in terms of benefits, except for some quirky stuff like they can’t contribute to the federal/military Thrift Savings Plan until they are commissioned, and their 4 years at USNA don’t count for military retirement but can count toward federal civil service retirement.

These complex issues come up every year on income tax dependency status, 529 plans, etc. Glad I don’t have to navigate it.
 
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Haveaniceday said:
529s for Academy expenses is a complex area. Some have used them to pay USCGA expenses. However, cadets are not considered full time students by the IRS, they are active duty soldiers. As such, the academy does not issue 1099 forms for college expenses like civilian schools do. 1099s are needed to justify TAX FREE 529 draws on the tax return. But, because they are not college students, after their first year they do qualify for the savers credit which is a valuable tax credit.

The bottom line is with the IRS you can either be a active duty soldier or full time student, not both. There are different rules for each.

West Point has issued guidance that cadets are not to file as full time college students, providing at least one precedent on this complex matter.

@Don't Give Up the Ship gives an IRS accepted option to get your 529 funds out. As he says the 10% penalty is waived for academy kids. I would recommend an enhancement: as he describes if your cadet uses his pay to fund a Roth IRA (a very good idea), then that will make them eligible for the savers credit, and since they make about 13k a year as a cadet, the IRS credit is more than their tax. That extra credit can be used to cover the taxes due on 529 withdrawals. Careful planning is required but spreading the 529 non-qualified (taxable) withdrawals over 3 low earning academy years can lead to significant tax saving.

Great info from @Don't Give Up the Ship .

A final FYI, USCGA will does several small loans as gear, laptops, etc. are issue, so it is kind of an ongoing process. Cadets only are required to buy books from the cadet store their first year. After that they can use Amazon or whatever saving significant funds.

Best to check with a tax accountant.
Click to expand...
What is relevant for a 529 withdrawal for a service academy cadet is NOT whether or not they receive a 1099 or 1098T or whether or not they are considered a student. What matters is that as a service academy cadet beneficiary for a 529 plan or an ESA for which there was a withdraw up to a certain amount is a specific exception (for the penalty) under the IRC Section 530 (for ESAs) and Section 529 of the IRC uses the same exceptions (section 529 sends you to section 530 for the exception). The penalty exception applies if the distribution was: "...(iv)made on account of the attendance of the designated beneficiary at the United States Military Academy, the United States Naval Academy, the United States Air Force Academy, the United States Coast Guard Academy, or the United States Merchant Marine Academy, to the extent that the amount of the payment or distribution does not exceed the costs of advanced education (as defined by section 2005(e)(3) of title 10, United States Code, as in effect on the date of the enactment of this section) attributable to such attendance".
 
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Haveaniceday said:
As you point out there are various United States Code cites that conflict. For example 38 USC 1965 (1) (d) states cadets are active duty. I would not bet the farm in an IRS audit on the one USC cite you refer to. Guidance from the academies such as the letters from a JAG officer in 2021 attached below, I would consider to be controlling on this matter.

As I have referred to earlier, there are no "qualified educational expense" at a military academy, as they are not considered to be educational institutions by the Dept. of Education. Thus, the Academy will not issue you a IRS form 1098-T for education expenses.

You can make non-qualified withdrawals from your 529 for any reason and pay the appropriate tax. I recommend you have any non-qualified draw from a 529 be paid to the cadet and their SSN, as they will likely be in a lower tax bracket than the parent.

Recommend you consult a CPA if you wish to pursue "qualified expenses" from a military academy as that position is not supported by the attachments below.

Attached are source documents published by USMA that explain the correct status and tax situation for Cadets you may find helpful:

Good luck!
Click to expand...
There is a flaw in the info provided by the Army attorney. He indicates that the cadets are full time students. This means if the student does not provide over half their own support and is under 24 then the parent can claim the dependent as a qualifying child and the dependent may not claim themselves. Qualifying child requires that the child not provide more than half their own support. Qualifying relative requires the taxpayer claiming the dependent to provide over half the dependent's support. These are important differences. The question becomes how much is provided by the cadet, by the government, and by the parents? And I don't know the answer to that at the moment.
 
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