Author Topic: 529 Redemption  (Read 294 times)

jmswtc

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529 Redemption
« on: September 27, 2018, 08:25:43 AM »
Hello,

If I am liquidating a 529 plan that I did not use in college because of scholarships, it appears based on what I read online that I can avoid the 10% penalty and just pay income tax on the earnings portion of my 529 balance.

As far as taxes go, is this something that I would report at the end of the year come tax filing season? Obviously I won't have taxes taken out right off the bat if I withdraw the full amount. I'm just wondering how this is taken care of at the end of tax season.

I used about $4500 for college expenses in my final year of school that I have already withdrawn (and spent), but still have about $17k left in the account so will I have to prove that I used the initial $4500 for school?

Also, has anyone withdrawn from a 529 that they didn't have to use because of scholarships received? Is there any formal process of proving you had scholarships in order to avoid the extra 10% withdraw penalty?


Any help is much appreciated!



secondcor521

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Re: 529 Redemption
« Reply #1 on: September 27, 2018, 09:23:30 AM »
Hello,

If I am liquidating a 529 plan that I did not use in college because of scholarships, it appears based on what I read online that I can avoid the 10% penalty and just pay income tax on the earnings portion of my 529 balance.

You are correct.  See https://www.irs.gov/publications/p970#en_US_2017_publink1000178567, item 3a.

As far as taxes go, is this something that I would report at the end of the year come tax filing season? Obviously I won't have taxes taken out right off the bat if I withdraw the full amount. I'm just wondering how this is taken care of at the end of tax season.

Yes.  You will (well, you should) receive a Form 1099-Q from the school in January or February.  You'll go through the calculations at https://www.irs.gov/publications/p970#en_US_2017_publink1000178534 and come up with a taxable income figure that will go on Line 21 of your Form 1040.  This will increase your taxable income.  If you have not paid enough via withholding, you may be subject to underwithholding penalties.

I used about $4500 for college expenses in my final year of school that I have already withdrawn (and spent), but still have about $17k left in the account so will I have to prove that I used the initial $4500 for school?

You should keep the relevant records with a copy of your tax return.  I keep the last three years of mine with all supporting documents.  Some places recommend keeping copies of your return with all supporting documents even longer.  Taxes in the United States are done on the honor system with occasional audits.  If you are audited and cannot produce the relevant documentation, then the IRS probably will adjust your tax return for you and you will owe the additional tax, and possibly interest and penalties.

Also, has anyone withdrawn from a 529 that they didn't have to use because of scholarships received? Is there any formal process of proving you had scholarships in order to avoid the extra 10% withdraw penalty?

Any help is much appreciated!

I haven't yet but I am keeping track of the scholarships my kids have received so that we have the flexibility to do so later.  My kids are still going through college and I don't know how much it will cost, so I'd rather leave that money in the 529 for now until they get closer to finishing.  But if they finish and there is leftover money in their 529s, I will have the scholarship records and can thus avoid the 10% withdrawal penalty.  I will also transfer ownership of the 529's to them so they can withdraw at their (likely) lower income tax brackets.

The answer here is the same as your question above about the $4500:  You should keep good records substantiating your calculations so that if the IRS audits your return you will have the documentation available and can explain and justify the numbers on your tax return.

jmswtc

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Re: 529 Redemption
« Reply #2 on: September 27, 2018, 09:42:24 AM »
Secondcor521,

Thanks for the detailed response! That pretty much answered everything I was unsure of!