Author Topic: 529 for three people, etc.  (Read 2113 times)

milliemchi

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529 for three people, etc.
« on: March 15, 2017, 03:04:29 PM »
My mom plans to gift me about $30K, give or take. My 403(b) is not maxed out, but our college funds are bordering on underfunded, and those are my first priority at the moment. Since we only have so much leftover cash, our current strategy was to fund two Roth IRAs (me, husband) first, with the idea that that will be the money drawn down for college expenses. For kid #1, we'll draw our deposits, for kid #2, husband will be over 59 1/2, so we will be able to draw down his earnings too. If there are some scholarships involved, which is highly likely, this should work well. However, just to be safe, and to diversify (most of our money is in the 403(b)), I would rather dump the $30K into a post-tax account (529) then into my 403(b).

It is very likely that my kids might get full tuition paid for for college (my job benefit), and that's why we initially did not have a 529. In the meantime, I figured out that a) the non-tuition costs are comparable to tuition, which I didn't figure out in my initial calculation, b) that after a number of years, paying the 10% penalty on non-educational expenses is still better than using a regular taxable account, and c) that my life goals now include spending about $25K on a master's degree. So there is a valid reason to dump the $30K into a 529.

1. Since the order of needing education money would be: me, DD, DS, I thought that for simplicity, I could just open one 529 in my name, then transfer to DD when she starts college, then transfer to DS when he starts college. I don't see a problem with this. Am I overlooking something? Is there any reason to have multiple 529s if our education years do not overlap?

2. For need-based scholarships, it will be beneficial for my child to draw the money from 529, rather than us (the parent). Are we OK with this plan, as long as I transfer the 529 to my daughter before she starts school? I don't foresee any need-based aid for us, but you never know.

3. As a default choice, I was going to open the 529 with Vanguard, where our other accounts are. Is that as good as any? Is there a reason to search around for a better one? Is the Vanguard one self-directed? I would prefer to pick my own mix of stocks and bonds, rather than put my money into a pre-defined fund.

seattlecyclone

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Re: 529 for three people, etc.
« Reply #1 on: March 15, 2017, 10:46:16 PM »
Quote
a) the non-tuition costs are comparable to tuition, which I didn't figure out in my initial calculation,

This is really variable. Don't accept the college financial aid office's budget as gospel. Those numbers generally assume you'll be staying in the dorm with a full meal plan, buying brand new textbooks and lighting them on fire at the end of the semester rather than reselling them, flying across the country on breaks to visit family, etc. There are plenty of ways to keep this cost down, especially if the kid goes to school in your town (which I assume is the case since you mention taking advantage of a tuition benefit).

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b) that after a number of years, paying the 10% penalty on non-educational expenses is still better than using a regular taxable account,

Have you taken into account the fact that the gains in a 529 are taxed as regular income rather than capital gains? You're right that this can still be better than a taxable brokerage account after "a number of years," but the number is pretty high.

Quote
1. Since the order of needing education money would be: me, DD, DS, I thought that for simplicity, I could just open one 529 in my name, then transfer to DD when she starts college, then transfer to DS when he starts college. I don't see a problem with this. Am I overlooking something? Is there any reason to have multiple 529s if our education years do not overlap?

Sure, nothing wrong with this. There are no tax consequences to changing the beneficiary on your 529.

Quote
2. For need-based scholarships, it will be beneficial for my child to draw the money from 529, rather than us (the parent). Are we OK with this plan, as long as I transfer the 529 to my daughter before she starts school? I don't foresee any need-based aid for us, but you never know.

I'm pretty sure that the FAFSA counts a 529 as a parental asset, so there would be no difference whether the money is in a 529 or a regular brokerage account. However the FAFSA completely ignores retirement account balances.

If your school doesn't use the FAFSA they could apply whatever other arbitrary rules they want though.

Quote
3. As a default choice, I was going to open the 529 with Vanguard, where our other accounts are. Is that as good as any? Is there a reason to search around for a better one? Is the Vanguard one self-directed? I would prefer to pick my own mix of stocks and bonds, rather than put my money into a pre-defined fund.

We opened our son's 529 with Vanguard. It doesn't have the very lowest expense ratios out there (I think California wins there), but it's close and I already have a bunch of other money with Vanguard and I didn't want to start a relationship with yet another financial institution. They do have a few predefined index-fund based "portfolios" that you have to choose from. No choice to just buy arbitrary stocks though.

I personally wouldn't recommend even considering a 529 until you're maxing out all of your retirement accounts. You generally won't owe early withdrawal penalties if you take money from your retirement accounts for qualified education expenses, which can make this a more flexible option than the 529. You can use the money for education if you need it, or if you don't you can save it up for your own future. But if you save more in a 529 than you need, the growth counts as regular income plus a penalty. Not great.

milliemchi

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Re: 529 for three people, etc.
« Reply #2 on: March 15, 2017, 11:33:16 PM »
All great points.

I'm pretty sure that the FAFSA counts a 529 as a parental asset, so there would be no difference whether the money is in a 529 or a regular brokerage account. However the FAFSA completely ignores retirement account balances.
Yes, that was another reason we initially went with Roth IRAs over 529.
I thought that 529 funds are counted as the asset of whoever is the beneficiary. Have to check on this one.
Also, I did not ask about asset considerations, but rather income - if the child draws it down, they are in a lower tax bracket, and it also doesn't bump the parent income for next year's aid calculation. It would be only the gains that count as income though... I need to read up some more, it seems.

I personally wouldn't recommend even considering a 529 until you're maxing out all of your retirement accounts. You generally won't owe early withdrawal penalties if you take money from your retirement accounts for qualified education expenses, which can make this a more flexible option than the 529. You can use the money for education if you need it, or if you don't you can save it up for your own future. But if you save more in a 529 than you need, the growth counts as regular income plus a penalty. Not great.
I think here you mean taking funds out from IRAs for education, right? I don't think I can use the 403(b) (generally=401(k)) for tuition. I'll check. Our IRAs are after-tax, and we already max out the contributions. So, it's 529 or a taxable account. Also, I have two kids, I'm sure we can spend $30K in eight college years.

The one thing 529 has going for it is that the gains are not taxed ever if used for education. That may or may not be a significant amount, given the volatility in the markets.

johnny847

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Re: 529 for three people, etc.
« Reply #3 on: March 15, 2017, 11:43:10 PM »
1) If you aren't already aware, your mom is supposed to file a gift tax form. If the gifts between a gifter giftee pair exceed $14k in a single calendar year, gift tax forms must be filed. If the gifter is married, then instead of a $14k limit it is a $28k limit.
Practically speaking, even though the gift tax forms must be filed, unless your mother dies a very rich person, gift taxes aren't ever going to be paid. Any gifts over the annual exclusion amount count against hte lifetime estate tax limit, which is currently $5.49 million dollars (double that if married). Any inheritance your mother leaves is counted against this lifetime limit as well. If after all of that the limit has been used up, then anything else is subject to estate taxes of 40% or so, i forget the exact number.

2) Be aware that 529 funds can be used tax and penalty free for room and board expenses if the student is enrolled at least half time. Even if your kids get full scholarships, 529 money can still be used for this.
The actual amount that can be used as room and board is the greater of
a) The cost of attendance figures published by the financial aid office for room and obard
b) The actual amount charged for room and board by the university.
https://www.irs.gov/publications/p970/ch08.html

3) In the event your kid gets a scholarship, you use the 529 funds for room and board, and you still have money left over, you have another option: you are allowed to withdraw 529 money up to the value of the scholarship penalty (but not tax) free. http://www.kiplinger.com/article/college/T002-C001-S001-the-529-plan-scholarship-exception.html

4)
Quote
1. Since the order of needing education money would be: me, DD, DS, I thought that for simplicity, I could just open one 529 in my name, then transfer to DD when she starts college, then transfer to DS when he starts college. I don't see a problem with this. Am I overlooking something? Is there any reason to have multiple 529s if our education years do not overlap?

Sure, nothing wrong with this. There are no tax consequences to changing the beneficiary on your 529.

This is incorrect. Taken from the US Code
Quote
(5) Other gift tax rulesFor purposes of chapters 12 and 13—
(A) Treatment of distributions
Except as provided in subparagraph (B), in no event shall a distribution from a qualified tuition program be treated as a taxable gift.
(B) Treatment of designation of new beneficiary
The taxes imposed by chapters 12 and 13 shall apply to a transfer by reason of a change in the designated beneficiary under the program (or a rollover to the account of a new beneficiary) unless the new beneficiary is—
(i) assigned to the same generation as (or a higher generation than) the old beneficiary (determined in accordance with section 2651), and
(ii) a member of the family of the old beneficiary.
See also 5) at http://www.fa-mag.com/news/avoiding-section-529-plan-pitfalls-6204.html
Changing it from yourself to your kid subjects the entire 529 balance to a gift tax.

5) FAFSA isn't the end all be all. Some schools practice gapping, which is where the FAFSA says your EFC (expected family contribution) is $X, but they tell you you're going to have to pay more than $X.

6) Should you decide to use 529s, you need to coordinate the usage of 529 money with the LLC (lifetime learning credit), AOTC (American Opportunity Tax Credit), and/or the tuition and fees deduction. There are many rules to them that would take a while to explain, but the point I want to raise right now is any QHEE (qualified higer educational expenses) that you claim as tax free use of 529 money CANNOT be overlapped with QHEE you use to claim the AOTC. You must pay money out of pocket, not from 529 money, to be able to claim these credits.
LLC is 20% of first $10k, AOTC is 100% of the first $2k and 25% of the second $2k. Tuition and fees deduction is an above the line deduction of up to $4k.

What state are you in? Does your state give a tax deduction for 529 contributions?

seattlecyclone

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Re: 529 for three people, etc.
« Reply #4 on: March 16, 2017, 01:36:47 AM »
I think here you mean taking funds out from IRAs for education, right? I don't think I can use the 403(b) (generally=401(k)) for tuition. I'll check.

I was talking about any retirement account you're allowed to withdraw from when the kids are in school. This table indicates that direct withdrawals from a 401(k) or 403(b) would be subject to the penalty if used for education, but that restriction is trivially bypassed by first rolling it over to an IRA. However if you're still working at that time, you can't get at your 403(b) funds, so that's off the table regardless.

I think if you're absolutely, 100% certain that you'll need the money for education, a 529 is a fine place to put that cash. If there's any doubt, you may prefer the retirement accounts instead. You'll still have some Roth basis to draw from for any education expenses that end up exceeding your 529 balance.

3) In the event your kid gets a scholarship, you use the 529 funds for room and board, and you still have money left over, you have another option: you are allowed to withdraw 529 money up to the value of the scholarship penalty (but not tax) free. http://www.kiplinger.com/article/college/T002-C001-S001-the-529-plan-scholarship-exception.html

This is true, but the gains still count as regular income in this case. This tax treatment is generally worse than a regular brokerage account where you get the preferential capital gains rate. Don't put more in a 529 than you know you'll need for education.

Quote
4)
Quote
1. Since the order of needing education money would be: me, DD, DS, I thought that for simplicity, I could just open one 529 in my name, then transfer to DD when she starts college, then transfer to DS when he starts college. I don't see a problem with this. Am I overlooking something? Is there any reason to have multiple 529s if our education years do not overlap?

Sure, nothing wrong with this. There are no tax consequences to changing the beneficiary on your 529.

This is incorrect. Taken from the US Code
Quote
(5) Other gift tax rulesFor purposes of chapters 12 and 13—
(A) Treatment of distributions
Except as provided in subparagraph (B), in no event shall a distribution from a qualified tuition program be treated as a taxable gift.
(B) Treatment of designation of new beneficiary
The taxes imposed by chapters 12 and 13 shall apply to a transfer by reason of a change in the designated beneficiary under the program (or a rollover to the account of a new beneficiary) unless the new beneficiary is—
(i) assigned to the same generation as (or a higher generation than) the old beneficiary (determined in accordance with section 2651), and
(ii) a member of the family of the old beneficiary.
See also 5) at http://www.fa-mag.com/news/avoiding-section-529-plan-pitfalls-6204.html
Changing it from yourself to your kid subjects the entire 529 balance to a gift tax.

Thanks for the clarification. I learned something. I was going off of this IRS publication about 529 plans, which mentions no income tax consequences for changing the beneficiary. The gift tax is of course a different thing entirely. As you pointed out already, the gift tax is hardly worth worrying about unless you plan for your taxable gifts and estate to total more than roughly $5.5 million ($11 million for a couple). You'll have to file some paperwork to report the gift, but that's all you'll have to do.

Quote
5) FAFSA isn't the end all be all. Some schools practice gapping, which is where the FAFSA says your EFC (expected family contribution) is $X, but they tell you you're going to have to pay more than $X.

True as this may be, I'm not sure how it's relevant to the decision about 529 vs. a brokerage account. If the two types of accounts are treated the same by the FAFSA, any school using the FAFSA number to determine their financial aid would presumably give the same amount of aid whichever type of account you choose, "gapping" or no.

johnny847

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Re: 529 for three people, etc.
« Reply #5 on: March 16, 2017, 06:32:22 AM »
3) In the event your kid gets a scholarship, you use the 529 funds for room and board, and you still have money left over, you have another option: you are allowed to withdraw 529 money up to the value of the scholarship penalty (but not tax) free. http://www.kiplinger.com/article/college/T002-C001-S001-the-529-plan-scholarship-exception.html

This is true, but the gains still count as regular income in this case. This tax treatment is generally worse than a regular brokerage account where you get the preferential capital gains rate. Don't put more in a 529 than you know you'll need for education.

I agree, but I'm just pointing out that it's not a humongous loss if someone gets a scholarship.

Quote
5) FAFSA isn't the end all be all. Some schools practice gapping, which is where the FAFSA says your EFC (expected family contribution) is $X, but they tell you you're going to have to pay more than $X.

True as this may be, I'm not sure how it's relevant to the decision about 529 vs. a brokerage account. If the two types of accounts are treated the same by the FAFSA, any school using the FAFSA number to determine their financial aid would presumably give the same amount of aid whichever type of account you choose, "gapping" or no.

But brokerage accounts are NOT treated the same as FAFSA. On the surface, they are treated the same because they're both just assets that are assessed at the same rate.

However, 529s shield income. Here's what I mean

Scenario 1
OP contributes $10k to a 529 in year 0. During year 0, it throws off $200 in dividends. Along with the dividends, capital appreciation brings the total account balance is $10,500.
In year 1, OP's kid goes to college and needs to fill out FAFSA. The $10,500 is assessed as an asset (at ~5%).
Also during year 1, OP sells all the shares in the 529 and withdraws the money.
In year 2, there's no more assets left to assess. The 529 withdrawal doesn't affect FAFSA forms (fyi, if the 529 was owned by a grandparent, such a withdrawal would count as untaxed income on FAFSA).

Scenario 2
OP purchases $10k of VTSAX in year 0. During year 0, it throws off $200 in dividends. Along with the dividends, capital appreciation brings the total account balance is $10,500.
In year 1, OP's kid goes to college and needs to fill out FAFSA. The $10,500 is assessed as an asset (at ~5%). The $200 is counted as income (at ~47%).
Also during year 1, OP sells all the shares for a $300 capital gain.
In year 2, there's no more assets left to assess. The $300 capital gain is assessed as income (at ~47%).

See the difference?
The difference is mitigated by using a tax efficient fund and by selling your shares with the smallest unrealized gain (as you normally would even if college expenses were not involved). But there still is a difference.

milliemchi

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Re: 529 for three people, etc.
« Reply #6 on: March 16, 2017, 07:04:54 AM »
Just to clarify...

The tuition will likely be covered as a job benefit that can cross state lines, not by a scholarship, so any 529 money should be planned to cover other expenses. There will likely be scholarships too, but that's less guaranteed. Need-based aid is not likely for us, but should things turn out so that we qualifyafter all, then we'll need every dollar we can get.

There's me and my husband, and my mom and dad, so we can receive $56K without triggering gift taxes. I was not aware that transferring from me to a child would be considered a gift. In that case, it's best to put the 529 in my daughter's name first, then transfer to my son. Then the whole thing is gift tax free.

I know that $5.49M is a lot of money, but I may live to be 90 as that runs in the family. In that case, just the money we have saved so far would grow to $21M. The estate tax exclusion will not keep up with the market for sure, and I may not use up the difference. Plus, I still have 12 (minimum to FIRE) to 17 (minimum to make use of the tuition benefit) years of work life ahead, so it's likely there will be a lot of money left. Plus, there's the home. Plus, there may be social security after all. I have kind of made a decision to donate much to charity, but it's still only kind of.

lthenderson

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Re: 529 for three people, etc.
« Reply #7 on: March 16, 2017, 08:14:49 AM »

Quote
1. Since the order of needing education money would be: me, DD, DS, I thought that for simplicity, I could just open one 529 in my name, then transfer to DD when she starts college, then transfer to DS when he starts college. I don't see a problem with this. Am I overlooking something? Is there any reason to have multiple 529s if our education years do not overlap?

Sure, nothing wrong with this. There are no tax consequences to changing the beneficiary on your 529.

One tax benefit you may be missing with only one account is that many states allow you to deduct a certain amount of your contributions to a 529 plan from your taxes. In my state, we can deduct up to $6478 per child as a married couple from our state taxes in 2017. We both contributed to both our children so in total we have a nearly $13k deduction next year.

milliemchi

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Re: 529 for three people, etc.
« Reply #8 on: March 16, 2017, 09:26:23 AM »
One tax benefit you may be missing with only one account is that many states allow you to deduct a certain amount of your contributions to a 529 plan from your taxes. In my state, we can deduct up to $6478 per child as a married couple from our state taxes in 2017. We both contributed to both our children so in total we have a nearly $13k deduction next year.

I just went to check, in IL it's $20K per beneficiary for joint filing. So it matters, thanks. Since I won't get the money until ~November, I'll make sure to deposit $20K in 2017, and the rest in 2018.

johnny847

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Re: 529 for three people, etc.
« Reply #9 on: March 16, 2017, 11:45:41 AM »
Just to clarify...

The tuition will likely be covered as a job benefit that can cross state lines, not by a scholarship, so any 529 money should be planned to cover other expenses. There will likely be scholarships too, but that's less guaranteed. Need-based aid is not likely for us, but should things turn out so that we qualifyafter all, then we'll need every dollar we can get.

There's me and my husband, and my mom and dad, so we can receive $56K without triggering gift taxes. I was not aware that transferring from me to a child would be considered a gift. In that case, it's best to put the 529 in my daughter's name first, then transfer to my son. Then the whole thing is gift tax free.

I know that $5.49M is a lot of money, but I may live to be 90 as that runs in the family. In that case, just the money we have saved so far would grow to $21M. The estate tax exclusion will not keep up with the market for sure, and I may not use up the difference. Plus, I still have 12 (minimum to FIRE) to 17 (minimum to make use of the tuition benefit) years of work life ahead, so it's likely there will be a lot of money left. Plus, there's the home. Plus, there may be social security after all. I have kind of made a decision to donate much to charity, but it's still only kind of.

Uh just to be clear, it's not just changing the beneficiary of a 529 from yourself to your kids that is subject to gift taxes. Making a direct contribution to a 529 with your kid as a beneficiary also triggers the gift tax. You are allowed to frontload up to 5 years worth of gifts into one year, and then avoid making contributions for the next four years, and still avoid the gift tax http://www.savingforcollege.com/articles/10-Rules-for-Superfunding-a-529-Plan-643

However, unless IL allows for you to defer the deduction for excess contributions into future years, I would advise against that.

FYI the $5.49M estate tax exclusion is for a single person. Since you're married, that estate tax exclusion is double that. Though I'm not sure what happens to the exclusion if one person dies earleir than the other.

milliemchi

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Re: 529 for three people, etc.
« Reply #10 on: March 16, 2017, 12:00:50 PM »
I'm clear on the gift taxes. But I didn't realize that switching 529 beneficiary from parent to child is considered a gift. This is probably because if I put it in for myself, then obviously it's not a gift, so transferring to child has to be. Makes sense.

milliemchi

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Re: 529 for three people, etc.
« Reply #11 on: March 16, 2017, 01:07:53 PM »
Some info that answers some of my original questions:

"Qualified distributions do not affect eligibility (i.e., qualified distributions do not count as income or a resource). Note that non-qualified distributions (i.e., distributions that are subject to federal income tax) do count as income to the distributee. Custodial 529 college savings plans owned by a student, where the student is both the account owner and beneficiary, are reported as a parent asset if the child is a dependent student and a student asset if the student is an independent student."

So it doesn't matter who owns the account (for asset reporting; my kids will be dependent) or who withdraws the funds (for income reporting; we will not withdraw non-qualified expenses unless the account grows really fast, in which case it's a good problem to have). I didn't even realize the difference between owner and beneficiary until I had responses from this thread.

Either way, if there are any funds left over when my son finishes college, assuming neither child goes to graduate school, the funds would have been in the account for 17 years. It takes 14 to break even (re 10% penalty) if we stay in the 25% tax bracket, and we're 3% ahead at 17 years. If we can go back to the 15% bracket, then we're 14% ahead in 17 years. Not much, but at least we're not losing money by sheltering it.

milliemchi

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Re: 529 for three people, etc.
« Reply #12 on: March 16, 2017, 01:16:14 PM »
Oh - and we could distribute the remainder to my son at the end of schooling, for a potentially 0% or 10% tax bracket. Then we're really ahead.

johnny847

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Re: 529 for three people, etc.
« Reply #13 on: March 16, 2017, 01:26:11 PM »
Some info that answers some of my original questions:

"Qualified distributions do not affect eligibility (i.e., qualified distributions do not count as income or a resource). Note that non-qualified distributions (i.e., distributions that are subject to federal income tax) do count as income to the distributee. Custodial 529 college savings plans owned by a student, where the student is both the account owner and beneficiary, are reported as a parent asset if the child is a dependent student and a student asset if the student is an independent student."

So it doesn't matter who owns the account (for asset reporting; my kids will be dependent) or who withdraws the funds (for income reporting; we will not withdraw non-qualified expenses unless the account grows really fast, in which case it's a good problem to have). I didn't even realize the difference between owner and beneficiary until I had responses from this thread.

Either way, if there are any funds left over when my son finishes college, assuming neither child goes to graduate school, the funds would have been in the account for 17 years. It takes 14 to break even (re 10% penalty) if we stay in the 25% tax bracket, and we're 3% ahead at 17 years. If we can go back to the 15% bracket, then we're 14% ahead in 17 years. Not much, but at least we're not losing money by sheltering it.

I know you didn't mention grandparents, but for your edification, that's not true for income reporting if the 529 account owner is a grandparent.
http://www.savingforcollege.com/grandparents/answer.php?grandparent_faq_id=10
In the event a grandparent wants to contribute to a 529, that 529 should be used during a student's last year (i think acutally you can stretch it to 1.5 years because calendar years and school years don't line up) of school, because it would count as income on the following year.

Oh - and we could distribute the remainder to my son at the end of schooling, for a potentially 0% or 10% tax bracket. Then we're really ahead.

I can't recall when the kiddie tax comes into play but you should look that up. When it does apply, income over a pretty low threshold gets taxed at YOUR income tax rates, not your kid's.

milliemchi

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Re: 529 for three people, etc.
« Reply #14 on: March 16, 2017, 01:32:24 PM »
Quote
I can't recall when the kiddie tax comes into play but you should look that up. When it does apply, income over a pretty low threshold gets taxed at YOUR income tax rates, not your kid's.

The kid will be 18 at end of college, and so filing his own tax return, no?

johnny847

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Re: 529 for three people, etc.
« Reply #15 on: March 16, 2017, 01:35:31 PM »
Quote
I can't recall when the kiddie tax comes into play but you should look that up. When it does apply, income over a pretty low threshold gets taxed at YOUR income tax rates, not your kid's.

The kid will be 18 at end of college, and so filing his own tax return, no?

https://www.irs.gov/taxtopics/tc553.html
Quote
Figure the child's tax on Form 8615 (PDF), Tax for Certain Children Who Have Unearned Income, and attach it to the child's tax return when:

The child's unearned income was more than $2,100
The child meets one of the following age requirements:
The child was under age 18 at the end of the tax year
The child was age 18 but less than 19 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships if the child was a full-time student), or
The child was a full-time student who was at least 19 and under age 24 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships)

At least one of the child's parents was alive at the end of the tax year
The child is required to file a tax return for the tax year, and
The child doesn't file a joint return for the tax year
Emphasis mine

ETA: Notice it says earned income. 529 withdrawals aren't earned income and hence a very large 529 withdrawal won't invalidate the bolded point.
« Last Edit: March 16, 2017, 01:45:03 PM by johnny847 »

milliemchi

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Re: 529 for three people, etc.
« Reply #16 on: March 16, 2017, 01:55:11 PM »
Well, that's strict.