Grandparent funding 529 and almost immediate withdrawal

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Saving$
Posts: 1630
Joined: Sat Nov 05, 2011 8:33 pm

Grandparent funding 529 and almost immediate withdrawal

Post by Saving$ » Wed Dec 05, 2018 12:27 am

A relative would like to help grandchild with college expenses, specifically with tuition.

Grandparent lives in GA, which has a 529 plan whose rules seem to allow account owner/contributor to deduct up to $2k/year for 529 contributions PER BENEFICIARY.

1. Can grandparent set up a 529, make $2k contribution in 2018, take the state tax deduction, make another $2k deduction in 2019, again taking the state tax deduction, and then use almost the entire amount in 2019 towards grandchild tuition? Can't find anything in the rules that prohibit this.

2. If the funds are used to pay tuition for a college that is not in GA, does the state tax deduction for the grandparent still apply? Again can't find anything in the recapture rules that indicate this is prohibited and/or the deduction is recaptured for out of state tuition payments

3. The rules seem to allow account owner/contributor to deduct up to $2k/year per beneficiary, and also to allow renaming of beneficiaries of accounts. Seems like if Grandparent wants to fund more than $2k/year for this grandkid - lets use $4k/year as an example - they could just set up another 529, naming a different grandkid as a beneficiary, take the deduction, and then later change the beneficiary to the name of the kid who is going to college, making all grandparents contributions toward college attending grandkids tuition state tax deductible. Can this be correct?

fujiters
Posts: 134
Joined: Tue Mar 06, 2018 2:17 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by fujiters » Wed Dec 05, 2018 3:29 am

The 2017 IT-511 Tax Booklet doesn't impose any restrictions on the deduct-ability of contributions to the state's 529 plan, aside from the $4000 limit per beneficiary for a couple MFJ.

1. There's no requirement to keep 529 funds in an account a certain length of time, and I haven't seen any indication that GA has any time requirement in order to qualify for the state tax deduction.

2. According to an IRS FAQ: "The beneficiary is generally not limited to attending schools in the state that sponsors their 529 plan." And according to GA's Office of the State Treasurer "Funds may be used at virtually any college or university in the United States, and many abroad."

3. This seems like it wouldn't be allowed due to the step transaction doctrine...but then again, the backdoor Roth also seems like it would fall afoul of that, and it's been explicitly sanctioned by the IRS. Hopefully someone more knowledgeable on this will weigh in.
“The purpose of the margin of safety is to render the forecast unnecessary.” -Benjamin Graham

User avatar
happymob
Posts: 552
Joined: Wed Nov 18, 2009 4:09 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by happymob » Wed Dec 05, 2018 7:04 am

If you get a state deduction, laundering money through a 529 plan is smart, even if you don't take advantage of the tax-free growth. The biggest downside is expenses paid through a 529 are not eligible for other higher ed tax credits, so you typically don't want to pay 100% via 529 as the tax credit (if eligible) are worth more than the state tax deduction.

Leemiller
Posts: 1060
Joined: Sat Jun 01, 2013 12:42 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by Leemiller » Wed Dec 05, 2018 8:56 am

I’ve never seen a 529 that allowed deductions for someone who wasn’t a parent/guardian. But perhaps GA is different.

Saving$
Posts: 1630
Joined: Sat Nov 05, 2011 8:33 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by Saving$ » Wed Dec 05, 2018 8:34 pm

happymob wrote:
Wed Dec 05, 2018 7:04 am
If you get a state deduction, laundering money through a 529 plan is smart, even if you don't take advantage of the tax-free growth. The biggest downside is expenses paid through a 529 are not eligible for other higher ed tax credits, so you typically don't want to pay 100% via 529 as the tax credit (if eligible) are worth more than the state tax deduction.
Another downside may be the 529 distribution counts as student income, and FAFSA expects the student to "contribute" the same amount in subsequent years, and so decreases the amount of other grants & aid for which the student may otherwise have been eligible.

Can someone please confirm that based on the current FAFSA cycle, a withdrawal from a grandparent owned 529 for which the student is the beneficiary won't affect undergraduate financial aid if the grandparent waits until spring semester of the student's sophomore year? ie
- 1/2018 withdrawal (sophomore year)
- 2018 income reported on 10/2019 FAFSA, which would apply to 2020/21 school year, so it does not apply because student getting a degree in 4 years would graduate by spring 2010.

Leemiller wrote:
Wed Dec 05, 2018 8:56 am
I’ve never seen a 529 that allowed deductions for someone who wasn’t a parent/guardian. But perhaps GA is different.
Per this article, about 20 states allow anyone who contributes to a 529 to take the deduction:
https://www.kiplinger.com/article/taxes ... plans.html
Last edited by Saving$ on Wed Dec 05, 2018 9:10 pm, edited 1 time in total.

User avatar
Steelersfan
Posts: 3544
Joined: Thu Jun 19, 2008 8:47 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by Steelersfan » Wed Dec 05, 2018 9:10 pm

Leemiller wrote:
Wed Dec 05, 2018 8:56 am
I’ve never seen a 529 that allowed deductions for someone who wasn’t a parent/guardian. But perhaps GA is different.
I live in a state (not GA) that would allow me to take a tax deductions for a grandchild's 529 plan. I elected to gift what I would have contributed to the 529 plan to my son, no strings attached, but with the belief he might contribute to his son's 529 plan and take the tax deduction against his income. That's worked fine for several years. Son gets a tax deduction and grandson gets a larger 529 plan.

MathWizard
Posts: 3081
Joined: Tue Jul 26, 2011 1:35 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by MathWizard » Thu Dec 06, 2018 10:01 am

Use the 529 first for expenses that Do Not Qualify (as qualified expenses for Educational tax credits)

Then pay qualified expenses, e.g. tuition, with your dollars, (not from a 529), up to $4000 if you
owe at least that amount of fed income taxes to get the max educational tax credit.

From:

Code: Select all

https://www.irs.gov/credits-deductions/individuals/qualified-ed-expenses
Even if you pay the following expenses to enroll or attend the school, the following are not qualified education expenses:

Room and board
Insurance
Medical expenses (including student health fees)
Transportation
Similar personal, living or family expenses

Saving$
Posts: 1630
Joined: Sat Nov 05, 2011 8:33 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by Saving$ » Thu Dec 06, 2018 5:22 pm

MathWizard wrote:
Thu Dec 06, 2018 10:01 am
Use the 529 first for expenses that Do Not Qualify (as qualified expenses for Educational tax credits)

Then pay qualified expenses, e.g. tuition, with your dollars, (not from a 529), up to $4000 if you
owe at least that amount of fed income taxes to get the max educational tax credit.
Grandparents do not qualify for either the Lifetime Learning Credit or the refundable American Opportunity Tax Credit unless the grandchild is their dependent. And since they are both tax credits, they only help the grandchild if grandchild income is high enough to have tax liability...

User avatar
dodecahedron
Posts: 3799
Joined: Tue Nov 12, 2013 12:28 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by dodecahedron » Thu Dec 06, 2018 5:34 pm

Saving$ wrote:
Thu Dec 06, 2018 5:22 pm
MathWizard wrote:
Thu Dec 06, 2018 10:01 am
Use the 529 first for expenses that Do Not Qualify (as qualified expenses for Educational tax credits)

Then pay qualified expenses, e.g. tuition, with your dollars, (not from a 529), up to $4000 if you
owe at least that amount of fed income taxes to get the max educational tax credit.
Grandparents do not qualify for either the Lifetime Learning Credit or the refundable American Opportunity Tax Credit unless the grandchild is their dependent. And since they are both tax credits, they only help the grandchild if grandchild income is high enough to have tax liability...
If grandchildren qualify as dependents of their parents, then the parents can claim American Opportunity Credit or Lifetime Learning Credit, *regardless* of which family member actually pays the tuition (e.g., could be parents paying, grandparents paying, or child paying--even out of a student loan or savings or job), but as long as the student qualifies as the dependent of another taxpayer, the taxpayer claiming the student as dependent also gets to claim the AOC or LLC.

So to preserve maximum tax benefits for the parents in such a case, the grandparents would do well to use their 529 to pay expenses such as room & board which are qualifying uses of 529 and do not interfere with the parents ability to claim AOC or LLC.

MathWizard
Posts: 3081
Joined: Tue Jul 26, 2011 1:35 pm

Re: Grandparent funding 529 and almost immediate withdrawal

Post by MathWizard » Thu Dec 06, 2018 5:36 pm

Saving$ wrote:
Thu Dec 06, 2018 5:22 pm
MathWizard wrote:
Thu Dec 06, 2018 10:01 am
Use the 529 first for expenses that Do Not Qualify (as qualified expenses for Educational tax credits)

Then pay qualified expenses, e.g. tuition, with your dollars, (not from a 529), up to $4000 if you
owe at least that amount of fed income taxes to get the max educational tax credit.
Grandparents do not qualify for either the Lifetime Learning Credit or the refundable American Opportunity Tax Credit unless the grandchild is their dependent. And since they are both tax credits, they only help the grandchild if grandchild income is high enough to have tax liability...
I should have quoted since I was responding to the previous post by Steelersfan below,
in regards to the grandparent gifting the son (the grandchild's father) who then can get the 529 state deduction.
IN addition to the 529 deduction, the grandchild's father can also get the AOC tax credit but not for expenses
paid for using the 529 money. By being careful which expenses the 529 money goes for, and which non-529 money
goes for, you can get a deduction and a tax credit.

I see how that was not clear without the quote.

I should add that scholarships which explicitly say they are for tuition can also prevent one from being able to
obtain the tax credit, since tuition is a big part of the qualified expenses. I had to be very careful about that with
my sons, and could not take the credit one year, losing out on a $2500 tax credit.


Steelersfan » Wed Dec 05, 2018 8:10 pm wrote:
Leemiller wrote: ↑Wed Dec 05, 2018 7:56 am
I’ve never seen a 529 that allowed deductions for someone who wasn’t a parent/guardian. But perhaps GA is different.
I live in a state (not GA) that would allow me to take a tax deductions for a grandchild's 529 plan. I elected to gift what I would have contributed to the 529 plan to my son, no strings attached, but with the belief he might contribute to his son's 529 plan and take the tax deduction against his income. That's worked fine for several years. Son gets a tax deduction and grandson gets a larger 529 plan.

Post Reply