529 withdrawal

tecolote

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Aug 16, 2017
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I have read many posts on various Academy sites but am curious whether anyone has completely withdrawn their cadet's 529 funds while they can. Apparently there is no penalty for doing so if the cadet has received a full scholarship. Why would anyone do so? Our financial advisor recommended we consider doing so before the law changes and disallows a full withdrawal without penalty.
TIA.
 

another13mom

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As of now, if you do not intend to roll the $$ to a younger sibling, you can retain the $$ in the account as there is no time deadline as to when the $$ must be withdrawn. You even have the option to retain it in the account and roll it to grandchildren. However, if you decide to withdraw the $$, while any withdrawal is penalty free, the person to whom the check is made out to by the fund (you or your cadet), must include the GAIN and only the GAIN in regular taxable income in the year the $$ is withdrawn. I'd suggest waiting until your cadet graduates and decides he or she does not wish to attend grad school (not including gov't paid grad school) before withdrawing (unless you need the $$ for something else) - and then withdraw on some regular interval annually so that taxes on gain are not disruptive to your overall tax liability.
 

Cerberi

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You can actually apply $17,500 of the 529 Funds to your Mid/Cadet's expenses at the SA's. This will rapidly accelerate the payoff of the ACE Loan and essentially allows the cadet/Mid to receive those funds tax free. (At USNA there is no reason to write this check earlier than junior year as the 'held pay' won't be released until the summer they are a rising senior.)

And USNA allows their Mids to participate in the National Outdoor Leadership School (NOLS) which charges tuition and awards college credit (if the Mid writes a paper) which 529 Funds can be used in addition to the $17,500 USNA can/will accept directly. (USAFA to my knowledge has nothing similar, but just pointing out 529 Funds can be used for 'education' purposes by Mids/Cadets.

USNA can/will accept the 529 Plan $s up to graduation day - essentially this is legally laundering $ as the $ becomes tax free cash to your Mid/Cadet. We are delaying sending the funds to USNA until DD starts her junior year just in case she might decide not to stay, plus it allows those funds to grow at some level vs 0% return if paid to the SA too early.

You would have to check with USAFA if they 'hold' onto it like USNA does or if they would disburse those funds to your cadet when the ACE Loan is fully paid.

I don't pretend to know your financial position and am not providing financial advice. I am just stating that I have researched this topic in great detail including direct talks with USNA's Finance Department and financial advisors. This is a legal option to use 529 Funds in support of Mids/Cadets.

P1 paragraph d in the link below:

https://www.usna.edu/_files/documents/2015-2016 Budget Book.pdf#search=529 plans
 

VelveteenR

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You can actually apply $17,500 of the 529 Funds to your Mid/Cadet's expenses at the SA's.
You can also apply this amount to a cruise, a new car, or a trip to Disneyland. If your kids is a student at an academy, the Military Family Tax Relief Act releases all 529 funds back to you penalty-free minus taxes on the gains. It is now your money to do with as you wish. If you apply any of it toward your cadet/mid's expenses, it is the same as just paying out of your pocket. The tax act was implemented to spare military families the penalty on funds that can no longer be used for college as the academies technically don't qualify as 529 institutions.

There has been excellent advice shared here about keeping funds available until your student commissions, but those funds are no longer restricted college savings; the money is yours to do with as you wish.

(Of course, if you have multiple children, you may keep the funds in the 529 and use them as intended for civilian college.)
 

Cerberi

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You can actually apply $17,500 of the 529 Funds to your Mid/Cadet's expenses at the SA's.
You can also apply this amount to a cruise, a new car, or a trip to Disneyland. If your kids is a student at an academy, the Military Family Tax Relief Act releases all 529 funds back to you penalty-free minus taxes on the gains. It is now your money to do with as you wish. If you apply any of it toward your cadet/mid's expenses, it is the same as just paying out of your pocket. The tax act was implemented to spare military families the penalty on funds that can no longer be used for college as the academies technically don't qualify as 529 institutions.

There has been excellent advice shared here about keeping funds available until your student commissions, but those funds are no longer restricted college savings; the money is yours to do with as you wish.

(Of course, if you have multiple children, you may keep the funds in the 529 and use them as intended for civilian college.)
And this is why it is dangerous to declare being an expert on a topic. I search high and low to make sure I could use at least some of those funds going through USNA. Thank you very much for making me aware of the broader options and not involving the SA's.
 

AROTC-dad

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VelveteenR 's statement is backed up by the IRS document in the link below.

https://www.irs.gov/individuals/military/highlights-military-family-tax-relief-act

Specifically, this says the penalty (10%) doesn't apply. Is there precedent for how the 'gain' is treated? (Sorry if I have strayed too far from the OP)
I believe any gain is taxed at ordinary income to the person receiving the 1099. If it is the cadet/mid, their tax bracket will be still pretty darn low, even as an O-1.
 

another13mom

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^^^ You can direct the withdrawal to be either in beneficiary's name or in the account owner's name. The 1099 will be issued to who ever receives the check and the GAIN will need to be included in ordinary income (front page of the 1040). I'd say, out of fairness, that if you are going to use the funds on a fun getaway with your spouse, or a second home for retirement, then if you are going to have the funds withdrawn in your cadet or young officer's name to lessen the tax cost for the withdrawal, that you pay the increased tax liability they will incur at the federal/state levels. However, if you're just turning over the funds to your cadet/grad, then by all means let them eat the tax liability.
 

Replevin

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Quick question. Has anyone dealt with the nuts and bolts of how this works when you do your, or your cadet's/midshipmen's taxes. Is TurboTax smart enough to ask if your child is attending a service academy when you put the 1099Q info in? Thanks
 

1meanteacher

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Quick question. Has anyone dealt with the nuts and bolts of how this works when you do your, or your cadet's/midshipmen's taxes. Is TurboTax smart enough to ask if your child is attending a service academy when you put the 1099Q info in? Thanks
I know you asked this about a month ago, but I just figured out the answer. TurboTax is NOT smart enough to ask if your child is attending a service academy. When I plugged the numbers in, TurboTax tried to charge the 10% withdrawal penalty for my USAFA Cadet.
 

Replevin

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OK. Thanks for the info. I guess I’ll try another avenue for her taxes.
 

FMHS-79

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Not sure if this helps, but I've found at least two references to Service Academies if you go into TurboTax forms mode:
* Student Information Worksheet: Question 2, What kind of school did the student in 2017?
* Form 1099-Q: Distributions Not Subject to Additional 10% Tax, Question 2d

I'm not a CPA, but it appears that the second will eliminate the 10% penalty on the distribution.
 

Replevin

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FMHS-79 Thanks for your help. Couple things I learned. You can't get to Forms Mode on Turbo Tax if you are using the online version. You have to use the down loaded version. However there is a work around. This question was answered on the Turbo Tax Forums:

Military academy attendance is an exception to the 10% penalty for 529 distributions. Is there a distribution code for this exception when reporting 1099-Q info?

There is no code, you simply enter the amount that is exempt from the penalty on line 6 of Form 5329.

Turbo Tax will do that for you; BUT they don't make it easy.

After entering the 1099-Q go to the education expenses section. You will have to go thru the entire education interview, essentially answering no to every question. You will eventually reach a screen titled "Tell us about your level of education". Check the box "Attended Military Academy in 2017". Also uncheck the "None of the above" box.

That worked for me and it took out the penalty.
 

another13mom

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^^ Yes, that method worked for me as well - just have to answer questions as if they are being spent on education until you get to the right question.
 

BrightSide

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Resurrecting this thread so we don't repeat things already covered. However, there is one detail that I have not seen covered in this or any of the other similar threads.

IF the Mid has a nicely funded 529 plan (stock market was overly kind and DH was quite clever over 18 year time span) and decides to pull the money out (after considering the.reasons covered above-other siblings, grad school, etc and after sending the allowed $17,500 for the ACE loan as a 2/C), how much can be pulled out each year without penalty??

His sister was allowed to pull out the amount of her scholarships (and received a handy 1098-T tax form each season). But I understand USNA does not send one.

All I can find is that the IRS allows SA attendees to withdraw the "cost of education" each year. This is different than the "value" of the education, which might be the amount used in a scholarship ceremony. The "cost" is probably closer to the amount a Mid would have to pay back after a separation. Can anyone give an estimated yearly amount for that? Is there a ballpark repayment number if a Mid were to elect not to sign their 2 and 7 (did I get the lingo right?☺). Or does anyone just know that magical maximum number?
 

AJC

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My 2nd Lt. son's 529 in now a log cabin in the woods.
The amounts allowable for withdrawal are equal to box 5 on the 1098-Q.
We simply withdrew less than that amount each year until we used it all up.
So far, no IRS notice saying we did it wrong.
 

BrightSide

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So, for my daughter (attending a regular college, not a SA), we received a 1099-Q from the institution that held the 529 plan that told us how much we withdrew. We also got a 1098-T that told us how much was exempt from the penalty due to scholarships.

Do the service academies send out a 1098-T? That would solve a lot of problems, but I read elsewhere that they did not.
 
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BrightSide

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Is it possible for moderators to move this to another category? It is relevant to all academies and perhaps someone elsewhere can answer the question.

Do SAs send 1098-Ts (my other research is telling me no) and if not, what is the maximum amount one can withdraw per year for a child attending a SA and not incur the 10% penalty?
 

Stealth_81

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You do not get a 1099-T. The “cost of education” which is what you can withdraw without penalty, will be communicated to parents during the first semester. I think it was around $51k per year when my son was there.

Stealth_81
 
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