SA and 529 Fund tax planning

Discussion in 'Service Academy Parents' started by MidwestDad, Feb 23, 2017.

  1. MidwestDad

    MidwestDad Member

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    Well there an older forum thread on this but since we are in the same boat now I figured I would ask around hoping someone out there is a CPA or tax atty :)

    Background: SAs are not 'Qualified' institutions for 529 withdrawals but are exempt from 10% penalty. You take money out, pay taxes on the investment gains, no penalty. Income is reported on your kid's income [1099Q] and taxed at their bracket rate [lower than yours usually.]

    We have ~$40K in DS' 529; he is appointed to SA and is youngest so no sibling to roll over to.

    I think the best case is to stop contributions and withdraw 1/4 of the account value during each calendar year he will be at SA prior to commissioning. [enroll 2017, finish 2021 so withdraw '17 - '20.]
    His tax bracket will never be lower before commissioning so this seems to make the most sense.

    We will use the $$ to cover uniform / computer etc etc costs at SA; what is left I will put in his nest egg account for his service years.

    Anyone else looking at this?
     
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  2. AJC

    AJC Member

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    I think that old thread makes mention of some provision for your situation.
    Also you may want to leave it where it is for now in case for some reason he has to leave the SA.
     
  3. AROTC-dad

    AROTC-dad Moderator 5-Year Member

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    Not a CPA, or attorney but I'm a fee only Certified Financial Planner.

    Agreed, your DS is likely never going to be in this low of a tax bracket, so the 1/4 per year for the next four makes sense. The basis of the 529 is not taxable. Only the capital gains are, so be sure to track this.
    Have the 529 custodian issue the 1099 to your DS so that tax burden is on him and not you.

    Even if your DS has no siblings to roll the funds to, you can also save the 529 for your DS's future children and let the compounding do its magic. (You can change beneficiaries later).

    @AJC also brings up a legitimate issue. Cadets can and do withdraw for a variety of reasons.
     
    Last edited: Feb 23, 2017
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  4. Capt MJ

    Capt MJ 10-Year Member

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    I would wait until he starts junior (2/c) year and signs his service obligation. You never know what will happen - Med DQ along the way, change of mind, etc. Mids do leave, for voluntary and involuntary reasons. No one ever thinks it will be their DS or DD. Hanging onto college money a bit longer might be prudent.

    It's all about risk analysis.

    There are many ways to approach this, and I am sure others will offer thoughts.

    His ACE loan covers all kinds of initial issue stuff at USNA, and is automatically repaid from his pay. As has been said many times, he can show up with the clothes on his back and a twenty, and he'll be fine. Expenditures will come in the form of travel money for you and him.
     
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  5. MidwestDad

    MidwestDad Member

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    $$ wont be spent; just parked in another account for grad school / plan B, etc etc. I figure he's earned it at this point and we paid full freight for his sibling so don't want that squabble coming between them ever.

    I'll have to analyze IRS brackets for $10K vs $20K income levels to see if delaying until start of 2nd/3rd year has any tax disadvantages [they would be minimal of course] but I have considered this contingency.

    I suspect we will do nothing beyond withdrawing initial costs in 2017, still leaves 3 years '18-'20 to spread the balance withdrawals over.
    I know they will front him the initial bill and deduct it later but its the least we can do considering. He can buy the barracks pizza with his extra pay if he wants.

    Thanks for the replies; I didn't see that anything had changed since the older thread but I'm not the tax code expert . . .
     
  6. AROTC Parent

    AROTC Parent 5-Year Member

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    Can't you leave the remaining in the 529 for grad school/plan B while on AD or after?
     
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  7. MidwestDad

    MidwestDad Member

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    "Can't you leave the remaining in the 529 for grad school/plan B while on AD or after?"

    Yes but its hard to predict that scenario; some do grad school while still AD / extend service, never do grad school etc.
    Certainty of undergrad enrollment was >90% with known timing; far more uncertainty with grad school / unknown timing.
    If he doesn't need for grad school and the 10% penalty applies that backfires.

    This does raise another important question - is the 10% penalty waiver valid in perpetuity to his SA attendance? i.e. if 529 fund is left intact until 2026? and not used for grad school after AD can a Class of 2021 SA grad claim the exemption? I am going to bet this is not addressed whatsoever in the 529 plan tax code; will have to read the fine print. That would certainly be the best of all scenarios.
     
  8. AROTC-dad

    AROTC-dad Moderator 5-Year Member

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    I cannot find a statute of limitations to the Service Academy exemption to the IRS 10% penalty.

    Here is the verbiage from the IRS site: (bold at the bottom is mine)

    Exceptions. The 10% additional tax doesn't apply to the following distributions.

    1. Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.

    2. Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she can't do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

    3. Included in income because the designated beneficiary received:
      1. A tax-free scholarship or fellowship grant (see Tax-Free Scholarships and Fellowship Grants in chapter 1);

      2. Veterans' educational assistance (see Veterans' Benefits in chapter 1);

      3. Employer-provided educational assistance (see chapter 11 ); or

      4. Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
    4. Made on account of the attendance of the designated beneficiary at a U.S. military academy (such as the USNA at Annapolis). This exception applies only to the extent that the amount of the distribution doesn't exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U.S. Code) attributable to such attendance.
     
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  9. MidwestDad

    MidwestDad Member

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    As I suspected - they did not anticipate this scenario and per the letter of the tax code there is no sunset. So as long as the fund balance does not exceed the Total Cost [for the 4 years in question] I don't think the exemption ever sunsets. As long as you can document actual academy costs for academic years beneficiary spent at SA you should be OK.

    That is wonderful news if true.
     
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  10. daninoah

    daninoah Member

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    529 accounts are held by the parent (usually) and the child is the beneficiary. Any income that needs to be reported on gains because of matriculation to a service academy will not be reported on the student's tax returns, but rather on the parent's.
     
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  11. AROTC-dad

    AROTC-dad Moderator 5-Year Member

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    The 529 custodian in many cases can be directed to assign the 1099 form to the beneficiary instead of the parents, thus redirecting the tax burden onto the student. Each State has its own 529 Plan Custodian with different rules, so your mileage may vary.
     
  12. jl123

    jl123 Member

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    The opportunity to pass on an investment in a tax deferred account could give the grand-kids a huge start.

    Coincidentally, I was reviewing the 529 plan this morning. Was considering transferring ownership to DS, but realized that while it is difficult to get around considering parent assets for undergrad financial aid, it may be easier for grad school.
     
    Last edited: Mar 1, 2017
  13. AROTC-dad

    AROTC-dad Moderator 5-Year Member

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    Changing ownership of a 529 plan (except in cases of death) is somewhat risky. There is no clear cut interpretation on whether the transfer is considered a distribution that is subject to penalty or not. The rules seem to vary from state to state. Some plans allow an owner to transfer a 529 plan to another person such as a spouse, child or grandchild with no restrictions. There is concern about IRS adding regulations to curb abusive use of this tactic. It would be best to contact your individual plan and verify the rules on ownership changes.

    Remember also, parental assets are assessed by FAFSA at 5.6% whereas if your son owns the assets, he is hit with a rate of 20%.

    Check out this article:
    http://www.morningstar.com/advisor/t/45786621/changing-529-account-owners.htm

    Feel free to PM me if you wish to discuss more details.
     
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  14. jl123

    jl123 Member

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    Thanks. Good information. Because of the complexity and uncertainty I decided to keep ownership of the 529 plan - really no downside to it and I prefer not to let the IRS make an after the fact determination.
     
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  15. elnavy

    elnavy Member

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    following this conversation: our Plebe actually OWED taxes to our state this year. Not much, but still, could not believe it. Need to adjust the with holding as we are in a high tax state. We do not claim her on our taxes now-she lived away last year for the entire year. 529 plan-thinking of making a withdrawal and having the 1099 form go to her for summer travel costs. I heard that if it is considered academic work during the summer, that one can use 529 funds to help cover costs. Has anyone heard of this?
     
  16. VelveteenR

    VelveteenR Just gathering dust in the nursery...

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    You can use those 529 funds for anything -- a trip to Disneyland, a manicure, a Tesla. If your kid is at a service academy, you can withdraw those funds for any reason, without penalty, except for tax on the gains. Not saying that's what you SHOULD do, just pointing out that there is no restriction on withdrawal/use as the Military Family Tax Relief Act absolves you from the 10% penalty for use for non-education purposes. There has been a lot of good discussion on this topic, and I'm in the camp that you disburse the funds to yourself on the same schedule you would if you were paying for college (a quarter of the total estimated cost per year), leaving a balance in the event your cadet/mid leaves the academy for any reason and needs funds for civilian education. If the amount in the 529 is less than the cost of a four-year education, you may want to leave the entire amount intact until your kiddo graduates, just to be safe. Then, pin on those bars, throw yourself a party, and move the rest into your retirement portfolio.
     
  17. AROTC-dad

    AROTC-dad Moderator 5-Year Member

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    Agree with @VelveteenR.

    Believe it or not, the SA's are not 529 qualified institutions as they are not in the Federal list for accepting Government student loans. (SMCs are)
     
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  18. Jcleppe

    Jcleppe 5-Year Member

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    That is pretty much what we did although we did not have a traditional 529, it was something called "The GET Program" in our state. Same thing happened we had a good chunk left over from both kid's accounts. We took the remaining out after each graduated.

    I was glad to see that last line because that's exactly what we did, well, maybe not the party but the rest went into the retirement account.
     
  19. MidwestDad

    MidwestDad Member

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    I just confirmed that our 529 plan [MI MESP] allows us to easily designate withdrawals to either ourselves or DS [beneficiary.] That is a nice flexibility for future tax decisions.
    [Just recently they are allowing online account access; they never had it for UGMA accounts before and using snail mail for everything really got old.]

    Interesting note - the 'old' withdrawal forms had a check box option for 'Service Academy' exceptions; now you just declare if it Is / Is Not to be used for qualified educational expenses. I have to call them to find out if they assess the 10% penalty for 'Is Not' withdrawals and if so how to get that waived for SA attendees.
     
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  20. cavu

    cavu Member

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    Probably should consult your tax professional before changing ownership to you kids as that might trigger tax/penalty issues. You could just continue to hold the account and change beneficiaries as appropriate after the grandkids are born.

    As an aside, we used part of the 529 as a graduation/commissioning gift. It seemed to make sense since the money was earmarked anyway.
     
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