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BulldogTom

529 Options - kids did not use it all

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Parents set up 529 plan many years ago.  Oldest did not use much, youngest is not going to use it all.   No grandkids as of now.   Are there any options for the parents to take the money without incurring 10% penalty on the earnings?   I have been looking but all I see is that withdrawals made for other than education expenses incurs the 10% penalty.  

Am I missing anything?

Thanks
 

Tom
Modesto, CA

 

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Tom, you are correct. They can withdraw the funds and use them for what ever but will be assessed the penalty and tax. Only exception is amounts used for educational expenses.

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The parents could use the funds for adult education for themselves and not pay the penalty.

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Thank you all for confirming.   What I was hoping to hear is that at a certain age (59 1/2?) they could make non-penalty withdrawals - but I did not find that answer.  

Parents are going into retirement.   Perhaps they will want to take some classes, but what they really want is to use the funds in retirement. 

Thanks again for your comments.

Tom
Modesto, CA

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By any chance, is the reason the youngest won't use the funds because they are entering a military academy and don't need the money?  Or have a tax-free scholarship? Because I think that allows them to withdraw and only pay tax, not penalty.  Or if youngest is disabled, and that is why they won't be using the funds. 

Other than that, I got nothing.

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For (obvious) Fresno State Tom and others:

I often try to talk clients OUT of creating a 529 plan.  The 529 plan was created by banks and financial institutions to appeal to loving and ambitious parents when there are other risk-free options available.

Little Johnny is 2 years old, and parents (perhaps with delusions) look ahead 16 years and see a grown-up Johnny with a cap and gown walking off the stage as valedictorian.  So they start a 529 plan with a smiling banker friend.  Johnny is not the valedictorian, in fact he is a high school dropout with a joint in his mouth and dresses like a heathen.  Presto!  The situation Tom talks of has come to pass.

Instead:  create an UGMA (or UTMA) under your state law, put the money in an aggressive investment account under the kid's social security number.  Don't tell Johnny you have funded the UGMA.  Johnny has to have $1050 in unearned income before he has to report anything.  My guess is that this will not happen until he is over 14 (unless there has been voracious funding).  When he is 18, the risk is gone and the gifts may be retracted or used for education without any risk.  All the accumulated income has already been taxed, thus there is no explosion of taxable earnings. There is never a tax on cumulative income, since the income in earlier years has been taxable all along, but below filing thresholds for the most part.

It is amazing how financial institutions lure people into tax-deferred vehicles, when the taxpayer believes in his own mind the income is tax free.  Tax-deferred vehicles are not tax-free, and as often as not, when they become taxable, the tax bracket is higher than when the deferral occurred.  Tax-deferred accounts such as IRAs, SEPs, and 529s also lose the tax benefit of capital gains which can occur within the account, and the "gains" ultimately suffer the fate of ordinary income.  Nowadays capital gains can be taxed at zero (up to a point).

The same argument applies to the classic scheme of investing in US Savings bonds for children and when they mature - instant slug of taxable interest.  Recognize the interest as it is earned instead of lump sum, while the kid is too young to incur taxable income.

Fresno State Tom - more than you asked for, and perhaps more than you cared to read...

 

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Elrod's example is another (type is up to you, good, bad, etc.) "reason" for a 529.  The account holder may end up on assistance of some sort, and the 529 can hold funds which do not alter the assistance.  For those who are on assistance of some sort, it is a good way for others to provide some funds without altering their eligibility.  Interest on earnings is not the worry in those cases.

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11 hours ago, Edsel said:

For (obvious) Fresno State Tom and others: 

Johnny is not the valedictorian, in fact he is a high school dropout with a joint in his mouth and dresses like a heathen.  Presto!  The situation Tom talks of has come to pass.

Fresno State Tom - more than you asked for, and perhaps more than you cared to read...

 

@Edsel - not the situation at all.   Both are good kids.   The first only got a two year degree and went into law enforcement.   Was his dream to be a public servant in the fire department but was too skinny, so he became a cop instead.   Even in CA, community college is cheap (except for books).

Second kid is smart, and is attending a state college.   When he is done, there will be money left over in the 529 plan.  

They saved too much.   They are wonderful parents, the kids are good, and there is no drug use before they go to church every Sunday.   These kids are not heathens.

Keep your generalizations away from my clients, especially ones that I have known for over 15 years.   That is probably more than you cared to read either.

I do agree with your financial planning points.   But it is too late now.  

Tom
Modesto, CA

 

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Wait, I thought that once the  youngest hit 30, any funds remaining could come out without that penalty!  I'll go look that up and report back.

As for the UGMA/UTMA - problem with those is the funds become the kid's at age 18.  So the kid with the joint is gonna blow the lot on weed.  

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5 minutes ago, Catherine said:

I'll go look that up and report back.

Well, that one went poof some time ago and my brain was accessing information from the late 1990's.  Another reason I never trust memorized standards - am I recalling this year's figures or the ones from a decade ago?

Any chance either of these kids will go to grad school some day?  Or take any kind of classes for fun and games?  Basket-weaving, history of baseball, philosophy of Cicero?  If so, hold the funds in the 529 until then.  Else take it out over time to minimize the chances of bumping into a higher tax bracket.

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9 minutes ago, Catherine said:

my brain was accessing information from the late 1990's.

I love this. :D  That is all.

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  • Haha 1

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2 hours ago, Catherine said:

As for the UGMA/UTMA - problem with those is the funds become the kid's at age 18.  So the kid with the joint is gonna blow the lot on weed.  

The theory was that he wouldn't tell the minor about the gift and then take it back later. In other words, steal it from them.

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I've had lots of parents who diligently plunked money into 529s and ended up with lots of earnings that escaped tax.  Plus in most states they get a deduction for contributions that lowers their state tax bill.  UGMA accounts belong to the minor and can't just be taken back--there have been lawsuits filed by grown children when that kind of theft has happened.  US savings bonds for education have to be in an adult's name (purchaser must be at least 24 years old), so you'd have to buy them in the child's name and report accrued interest every year.  That can be a pain to calculate, especially now that all bonds are "paperless" through Treasury Direct and don't allow the nice "inventory" you could create with the paper ones and quickly see the annual accrued interest.  (Just had one today where over $3500 in interest will escape taxation altogether.)  I do agree that people shouldn't put all of their savings dollars into retirement plans because if they do need the money the penalties are steep.

I thought clients were the ones whose minds were stuck in the 1990s (and before).  How many  clients do you have who want to deduct their credit card interest?  (Went away in 1986.)  Who think they have to buy another house within two years to avoid taxable gains?  (1997)  That they are Head of Household because a working adult child lives with them?  (circa 2006)

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20 hours ago, BulldogTom said:

Keep your generalizations away from my clients, especially ones that I have known for over 15 years.  

Tom, generalizations are not meant for any client, certainly not yours or those belonging to anyone else.  I am sorry you took offense.

Hawaii Bowl Dec 24 2017:

Fresno State 33, Houston 27.

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