## Calculating Tax on Unqualified 529 Withdrawal

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Topic Author
psy1
Posts: 67
Joined: Thu Jan 31, 2019 1:40 am

### Calculating Tax on Unqualified 529 Withdrawal

I am trying to see if I understand the taxation of an unqualified withdrawal from 529 plan in the case of an "overfunded" plan, realizing that I could leave the money in the plan for future generations.

My understanding is that I have the option to direct the withdrawal to my child who would owe the tax. In this case, say the 529 has 80% contributions and 20% earnings.

If my child is still in college, has no income, and files taxes independently as a single person he would have a standard deduction of \$12,200 and owe 10% federal tax on the first \$9,700 of income (i.e. the unqualified withdrawal). Therefore the federal income tax rate on the first \$21,900 is ~4.4%.

Suppose that in 2020, while still in college, the student took a \$100,000 unqualified withdrawal (in addition to qualified withdrawals). That means the ~\$20,000 in earnings would be taxable and subject to the 10% penalty. The resulting federal tax would be approximately \$20,000 X 0.044 = \$880 + \$2000 in penalties. That is an effective tax rate of 14.4% plus it liberates a lot of money from the 529 which seems like a compelling deal to me.

Are my assumptions and arithmetic correct?

Spirit Rider
Posts: 10989
Joined: Fri Mar 02, 2007 2:39 pm

### Re: Calculating Tax on Unqualified 529 Withdrawal

Your assumptions and results would only be correct if they were no longer college students or >= age 24. Non-qualified 529 distributions to a college student < age 24 are unearned ordinary income subject to the Kiddie Tax.

They would have an unearned standard deduction up to \$1100*, the next \$1100 would be subject to the dependent's 10% ordinary income tax rate and the next \$2600 would be subject to the trust 10% ordinary income tax rate. Amounts above that would be subject to 22%+ ordinary income tax rates in compressed trust brackets.

*The first \$750 in earned income reduces the unearned income standard deduction dollar for dollar down to \$350. The remaining \$350 is reduced dollar for dollar to \$0, when earned income exceeds \$12,200 - \$350. In all cases, the dollar for dollar reduction increases the amount taxed at the dependent's 10% ordinary income tax rate.

Topic Author
psy1
Posts: 67
Joined: Thu Jan 31, 2019 1:40 am

### Re: Calculating Tax on Unqualified 529 Withdrawal

Understood, thank you. I forgot ab out the kiddie tax.