Over $10k in taxes owed for using 529s

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harikaried
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Over $10k in taxes owed for using 529s

Post by harikaried » Sun Oct 15, 2017 2:07 pm

Anything we should have done differently or should do going forwards?

We had two 529 accounts that were fully funded to desired levels for two children (one still on the way) where we ended up withdrawing everything earlier this year for some investment. There was about $30k in gains, so we'll need to pay 28% income tax and 10% penalty for a total of around $10k, which is less than what we've already earned from the investment (and hopefully we continue to earn for many years).

Clearly we didn't consider needing the 529 money for non-education purposes when we funded the 529 accounts because otherwise we could have just put the money in a brokerage account and paid significantly less taxes for long-term capital gains.

Do we re-fund the 529 accounts to desired levels or just put money in a brokerage account for more flexibility? This would now be in the context of additional loan and income that we didn't have before, so the usual considerations for prioritizing investments, debt service, simplicity, etc. apply.

Anything else to consider?

The Wizard
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Re: Over $10k in taxes owed for using 529s

Post by The Wizard » Sun Oct 15, 2017 2:55 pm

Consider having a good sized Emergency Fund in the future, in addition to various tax sheltered accounts...
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cherijoh
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Re: Over $10k in taxes owed for using 529s

Post by cherijoh » Sun Oct 15, 2017 3:05 pm

harikaried wrote:
Sun Oct 15, 2017 2:07 pm
Anything we should have done differently or should do going forwards?

We had two 529 accounts that were fully funded to desired levels for two children (one still on the way) where we ended up withdrawing everything earlier this year for some investment. There was about $30k in gains, so we'll need to pay 28% income tax and 10% penalty for a total of around $10k, which is less than what we've already earned from the investment (and hopefully we continue to earn for many years).

Clearly we didn't consider needing the 529 money for non-education purposes when we funded the 529 accounts because otherwise we could have just put the money in a brokerage account and paid significantly less taxes for long-term capital gains.

Do we re-fund the 529 accounts to desired levels or just put money in a brokerage account for more flexibility? This would now be in the context of additional loan and income that we didn't have before, so the usual considerations for prioritizing investments, debt service, simplicity, etc. apply.

Anything else to consider?
Have you considered how much the 529 would have appreciated had you left the money in it? The stock market has been very hot lately. Your "profit" from this decision isn't the gain on the investment less the taxes and penalties but is instead the incremental gain on the investment (gain on investment - gain you would have had in 529) minus the taxes and penalties. In addition, if the new investment isn't tax-advantaged you need to discount it in the future for the taxes you will pay along the way. After making these adjustments, you will see if this decision ultimately made sense.

Once you are looking at it from the proper frame of reference, you will hopefully be able to answer whether or not it makes sense to re-fund the 529 accounts. But IMO you shouldn't re-fund the 529s unless you are prepared to leave the money there unless faced with a true financial emergency.

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abuss368
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Re: Over $10k in taxes owed for using 529s

Post by abuss368 » Sun Oct 15, 2017 3:16 pm

harikaried wrote:
Sun Oct 15, 2017 2:07 pm
Anything we should have done differently or should do going forwards?

We had two 529 accounts that were fully funded to desired levels for two children (one still on the way) where we ended up withdrawing everything earlier this year for some investment. There was about $30k in gains, so we'll need to pay 28% income tax and 10% penalty for a total of around $10k, which is less than what we've already earned from the investment (and hopefully we continue to earn for many years).

Clearly we didn't consider needing the 529 money for non-education purposes when we funded the 529 accounts because otherwise we could have just put the money in a brokerage account and paid significantly less taxes for long-term capital gains.

Do we re-fund the 529 accounts to desired levels or just put money in a brokerage account for more flexibility? This would now be in the context of additional loan and income that we didn't have before, so the usual considerations for prioritizing investments, debt service, simplicity, etc. apply.

Anything else to consider?
Hi harikaried -

In my opinion planning, and better planning, is the key. I would revisit your plan and consider building your cash balances. Having cash readily available provides additional comfort and peace of mind for emergencies and unforeseen events. In addition, it will possibly prevent one from taking unplanned distributions from a tax advantaged account.

There is an old saying and for good measure "cash is king".
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

delamer
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Re: Over $10k in taxes owed for using 529s

Post by delamer » Sun Oct 15, 2017 4:38 pm

So the withdrawal was not for an emergency, but because you found an investment that you believed would yield a return making it worth paying the penalties?

Not sure what type of advice you are looking for in that context. Invest in the 529s again, but don't take money out? Don't ever put money in 529s again because who knows when something more attractive will come along?

harikaried
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Re: Over $10k in taxes owed for using 529s

Post by harikaried » Sun Oct 15, 2017 4:41 pm

The Wizard wrote:
Sun Oct 15, 2017 2:55 pm
Consider having a good sized Emergency Fund in the future, in addition to various tax sheltered accounts...
I suppose one could say that our Emergency Fund/sources were not enough for this size of "emergency" where we did liquidate our taxable brokerage account and drew $50k from each 401k and HELOC in addition to emptying the 529 accounts. We have already repaid the HELOC incurring just a few $100s of interest, so that actually ended up being the cheapest source of money other than regular income already taxed. During this process, we did maintain an actual emergency fund for regular monthly expenses, but indeed, we were on the lighter side for a few months.

If counting cash, taxable brokerage, HELOC, and 401k loan as emergency fund from before this event, that would have been more than 3 years worth of emergency based on expected month expenses. So it seems that the suggestion of larger emergency fund here would effectively mean for us to put more in the taxable brokerage.

harikaried
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Re: Over $10k in taxes owed for using 529s

Post by harikaried » Sun Oct 15, 2017 4:52 pm

cherijoh wrote:
Sun Oct 15, 2017 3:05 pm
Have you considered how much the 529 would have appreciated had you left the money in it?
Indeed. I've been tracking that to figure out how much money we should put back into the 529 accounts if we were to maintain the originally decided desired amount. And there's also all the details of expenses other than the taxes on 529 withdrawal related to the transaction. But then again, not all things need to be considered as pure investment either where there's value obtained by us and others that are not directly quantified with dollars.
cherijoh wrote:
Sun Oct 15, 2017 3:05 pm
But IMO you shouldn't re-fund the 529s unless you are prepared to leave the money there unless faced with a true financial emergency.
I don't expect us wanting to make such a large transaction anytime soon, but I guess a hedge would be to equally fund both taxable brokerage and 529 accounts.

harikaried
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Re: Over $10k in taxes owed for using 529s

Post by harikaried » Sun Oct 15, 2017 5:01 pm

abuss368 wrote:
Sun Oct 15, 2017 3:16 pm
In my opinion planning, and better planning, is the key. … Having cash readily available provides additional comfort and peace of mind for emergencies and unforeseen events.
Perhaps by definition unforeseen events are hard to predict, but does anyone have something more concrete to get to "better planning?"

Maybe this large transaction was triggered by our paying off the mortgage on our house, so some reason we felt more comfortable taking on this risk? Or maybe something based on our age or (future) children's age that is tied to general ability or willingness to try to help the community now over the need/non-need for higher education dollars now? Or perhaps this was just some (potentially unfounded) response to changes in the education environment that may impact the need for 529 accounts still almost a couple decades before needing use?

harikaried
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Re: Over $10k in taxes owed for using 529s

Post by harikaried » Sun Oct 15, 2017 5:10 pm

delamer wrote:
Sun Oct 15, 2017 4:38 pm
Not sure what type of advice you are looking for in that context. Invest in the 529s again, but don't take money out? Don't ever put money in 529s again because who knows when something more attractive will come along?
Ah indeed. I was thinking that when making the original post. "Is it basically don't put money in 529s if you might take it out for non higher-education expenses?" Although to be clear, we didn't take the money out primarily as a "more attractive" investment, but it's nice that it is a profitable investment.

Maybe that's the actual key thing for us to consider. What are possible "nice expenses" that we are willing to pay for, and how do we plan for that changing over time or for different circumstances?

cherijoh
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Re: Over $10k in taxes owed for using 529s

Post by cherijoh » Sun Oct 15, 2017 5:42 pm

harikaried wrote:
Sun Oct 15, 2017 4:52 pm
cherijoh wrote:
Sun Oct 15, 2017 3:05 pm
Have you considered how much the 529 would have appreciated had you left the money in it?
Indeed. I've been tracking that to figure out how much money we should put back into the 529 accounts if we were to maintain the originally decided desired amount. And there's also all the details of expenses other than the taxes on 529 withdrawal related to the transaction. But then again, not all things need to be considered as pure investment either where there's value obtained by us and others that are not directly quantified with dollars.
Huh? Your original post said that you had sold the 529 to purchase an investment that had already made up for the taxes and penalties incurred by liquidating your 529. That post sounded like it was a purely a financial decision. My point was that people forget the opportunity costs when looking back on a financial decision to see if it was the right one to have taken.

This latest post makes me think you are masking a purchasing decision as an investment - e.g., buying a house that has appreciated more on paper than it cost you in penalties and fees for liquidating the 529. If you are getting intangible benefits from a purchase then in my mind it rarely qualifies as an investment.

mrsytf
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Re: Over $10k in taxes owed for using 529s

Post by mrsytf » Sun Oct 15, 2017 6:10 pm

Clearly we didn't consider needing the 529 money for non-education purposes when we funded the 529 accounts because otherwise we could have just put the money in a brokerage account and paid significantly less taxes for long-term capital gains.
Based on your earlier statement in the OP, it sounds like the withdrawal was not based on a hardship or any kind of emergency. In my mind a 529 plan is purely for the educational benefit of my kids. I don't even include that money in my mental computation of my net worth. It's essentially invisible. Given the taxes and penalties associated with using it for a non educational purpose I think this approach is the best approach. I would only liquidate a 529 account if I was about to be homeless or destitute without doing so. In the unlikely scenario that my child was not going to college I would reserve it for another child's benefit: either a niece, nephew or grandkid.

If you don't feel this way about any future contributions to your 529, I wouldn't bother contributing to one. Why would you voluntarily surrender 10% of your money? If I had a credit card that charged 10% interest I would be robbing Peter to pay Paul to avoid paying that. Go for the taxable brokerage and pay for college out of that if that is a priority for you. The best time to contribute to 529's is as early as possible to take advantage of the tax free growth. It sounds like you were so cavalier about the 529 money because the kids are small but as they get older you lose that tax free growth advantage.

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