How to handle 529 with full scholarship

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John Laurens
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How to handle 529 with full scholarship

Post by John Laurens » Wed Sep 11, 2019 9:01 am

Hello, Thank you in advance for your wisdom.

I have 3 teenagers that we have funded 529s through the years. My oldest, a senior, has received a letter of assurance, to USMA at West Point. This is his dream come true since he was in junior high. Assuming he receives an appointment, he will accept.

We have told our boys that whatever 529 assets are theirs in the hopes that they would make value based decisions in determining where they went to college. There is currently a little over 100k in his 529.

What is your advice on how to eventually make sure he receives the value of the 529 in a tax efficient manner. I suppose the best way would to hold on to the 529 for his possible graduate education or his future children.

Any advice would be appreciated.

Regards,
John

Prettyfrtnt
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Re: How to handle 529 with full scholarship

Post by Prettyfrtnt » Wed Sep 11, 2019 9:09 am

You are allowed to withdrawal the money in the event of a scholarship. West Point however may not equate to a scholarship... if you can document a cash value scholarship then you can withdraw the money without the penalty. You should do that to erase the capital gains. You could then fund a brokerage account or a Roth for him even just put the money back into the 529 with the taxes scrubbed.

From saving for college “There are a few special exceptions to the 10% penalty rule, including when the beneficiary becomes incapacitated, attends a U.S. Military Academy or gets a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you'll have to pay income tax on the earnings. ”

So it seems to me he should pull it out up to the amount each year he would have to pay income tax on the earnings. He is going to get pay as a cadet so you’ll have to use a tax calculator to figure out the amount. Each year to pull.
Last edited by Prettyfrtnt on Wed Sep 11, 2019 9:14 am, edited 3 times in total.

Big Dog
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Re: How to handle 529 with full scholarship

Post by Big Dog » Wed Sep 11, 2019 9:09 am

are the amounts reserved for the his siblings enuf to cover their college expense for four years? If not, then another option is that you could rename his 529 to a brother/sister and just give the West Pointer the equivalent cash in kind (assuming that you have the $).

Grad school is a possibility for him, but if he enjoys Army, might as well have them pay for Grad school, too.

And 'Grats. Thank him for serving.
You are allowed to withdrawal the money in the event of a scholarship. West Point however may not equate to a scholarship...
Yes, the academies count as a scholarship. But, taxes are still due on the earnings -- not the principal which was already paid with after-tax dollars.

https://www.savingforcollege.com/articl ... -529-plans

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greg24
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Re: How to handle 529 with full scholarship

Post by greg24 » Wed Sep 11, 2019 9:18 am

Huge congrats on West Point!

miamivice
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Re: How to handle 529 with full scholarship

Post by miamivice » Wed Sep 11, 2019 9:19 am

John Laurens wrote:
Wed Sep 11, 2019 9:01 am
I suppose the best way would to hold on to the 529 for his possible graduate education or his future children.

Any advice would be appreciated.

Regards,
John
There's more to life than savings taxes. HIs money would come in handy after college, for buying a house, buying a car, or who knows what else. I wouldn't pressure him to save the money for his future children that may or may not materialize. (Also, who knows what the college tuition scene will be in 30 years, also we have no idea if his unborn children will be college material.)

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John Laurens
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Re: How to handle 529 with full scholarship

Post by John Laurens » Wed Sep 11, 2019 9:46 am

Big Dog wrote:
Wed Sep 11, 2019 9:09 am
are the amounts reserved for the his siblings enuf to cover their college expense for four years? If not, then another option is that you could rename his 529 to a brother/sister and just give the West Pointer the equivalent cash in kind (assuming that you have the $).

Grad school is a possibility for him, but if he enjoys Army, might as well have them pay for Grad school, too.

And 'Grats. Thank him for serving.
You are allowed to withdrawal the money in the event of a scholarship. West Point however may not equate to a scholarship...
Yes, the academies count as a scholarship. But, taxes are still due on the earnings -- not the principal which was already paid with after-tax dollars.

https://www.savingforcollege.com/articl ... -529-plans

Thank you.

Approximately 60k is earnings. I’m the account owner he is the beneficiary. When we withdraw an equal amount of the value of “the scholarship” each semester, I assume the earnings are taxed as ordinary income? At my rate, not his? Potentially this would result in 20kish in taxes owed if taxed at my ordinary income tax rate.

Regards,
John

Topic Author
John Laurens
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Re: How to handle 529 with full scholarship

Post by John Laurens » Wed Sep 11, 2019 9:51 am

greg24 wrote:
Wed Sep 11, 2019 9:18 am
Huge congrats on West Point!
Thank you very much. Today hits home that I’m giving my kid over to a cause greater than myself. The gravity of my son, who’s the most mature 17 y/o one minute and still a knucklehead the next minute, taking a life long oath is starting to sink in.

Regards,
John

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RickBoglehead
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Re: How to handle 529 with full scholarship

Post by RickBoglehead » Wed Sep 11, 2019 9:56 am

John Laurens wrote:
Wed Sep 11, 2019 9:46 am
Big Dog wrote:
Wed Sep 11, 2019 9:09 am
are the amounts reserved for the his siblings enuf to cover their college expense for four years? If not, then another option is that you could rename his 529 to a brother/sister and just give the West Pointer the equivalent cash in kind (assuming that you have the $).

Grad school is a possibility for him, but if he enjoys Army, might as well have them pay for Grad school, too.

And 'Grats. Thank him for serving.
You are allowed to withdrawal the money in the event of a scholarship. West Point however may not equate to a scholarship...
Yes, the academies count as a scholarship. But, taxes are still due on the earnings -- not the principal which was already paid with after-tax dollars.

https://www.savingforcollege.com/articl ... -529-plans

Thank you.

Approximately 60k is earnings. I’m the account owner he is the beneficiary. When we withdraw an equal amount of the value of “the scholarship” each semester, I assume the earnings are taxed as ordinary income? At my rate, not his? Potentially this would result in 20kish in taxes owed if taxed at my ordinary income tax rate.

Regards,
John
The tax is at the ordinary income rate, and yes, the owner of the account pays the taxes, not the beneficiary.

I believe you could perform the following steps:

1) Change him to the owner, and then file the proper paperwork for the gift that you gave him, which would be well under the lifetime exemption.
2) He withdraws the funds each year, and he pays the tax due on the earnings at his rate.

We had leftover funds in our sons' 529s, and we kept the funds for our future grandchildren.
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FrugalConservative
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Re: How to handle 529 with full scholarship

Post by FrugalConservative » Wed Sep 11, 2019 9:59 am

Being accepted into West Point is an outstanding accomplish. Congrats

relativeflux
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Re: How to handle 529 with full scholarship

Post by relativeflux » Wed Sep 11, 2019 10:14 am

If I remember correctly, when I was at USAFA, we had to take out a small loan when we started, to cover the cost of uniforms and a computer. The "loan" was then payed back out of our monthly check for a couple years. I think outside scholarships could be applied to this loan. I wonder if a 529 could also be applied. Something to consider at least.

Ybsybs
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Re: How to handle 529 with full scholarship

Post by Ybsybs » Wed Sep 11, 2019 10:17 am

As a service academy graduate myself, I encourage you to consider leaving the money in the 529 for now.

You and he certainly hope USMA is a great place for him and that he does extremely well there. However, some do find that attending a service academy is not a good fit. Others thrive there but learn that the part of the armed forces where they really want to serve is not a line officer position. These students can and do leave their service academy within the first two years and finish their college education elsewhere.

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UpsetRaptor
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Re: How to handle 529 with full scholarship

Post by UpsetRaptor » Wed Sep 11, 2019 10:28 am

If something similar is fortunate enough to happen to me, I will tell my child: "Congratulations on the scholarship, now your 529 funds can be available for any post-undergrad education you may want to consider in the future - grad, phd, med, dental, nursing, pharmacy, law etc - if you want to go one of those routes and minimize your future debt. And if you don't go that route or there's otherwise any left over after that, it'll be used to seed your own kids' college funds. Congrats!"

As others have mentioned, you could also withdraw the scholarship funds penalty free, taxed as ordinary income. Personally, however, I plan on doing paragraph #1, unless some crazy unexpected thing happens that turns my financial life upside down.

Spirit Rider
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Re: How to handle 529 with full scholarship

Post by Spirit Rider » Wed Sep 11, 2019 12:25 pm

RickBoglehead wrote:
Wed Sep 11, 2019 9:56 am
The tax is at the ordinary income rate, and yes, the owner of the account pays the taxes, not the beneficiary.
Not necessarily true. Reference 26 U.S. Code § 529(c)(3)(A) Any distribution under a qualified tuition program shall be includible in the gross income of the distributee.

This means non-qualified distributions payable to the account owner are taxable to the account owner and likewise distributions payable to the beneficiary are taxable to the beneficiary.
I believe you could perform the following steps:
1) Change him to the owner, and then file the proper paperwork for the gift that you gave him, which would be well under the lifetime exemption.
2) He withdraws the funds each year, and he pays the tax due on the earnings at his rate.
Step 1) is not required before Step 2), but Step 2) is a good idea.

With the TCJA change to trust tax brackets for Kiddie Taxes. With scholarships, a minor or college student < age 24 can have non-qualified 529 distributions to them up to $4800/year in 529 taxable earnings with a maximum tax rate of 10%. With the standard deduction $12,200 (2019). This still allows a reasonable amount of W-2 wages before they those wages would be subject to taxation.
Last edited by Spirit Rider on Wed Sep 11, 2019 3:35 pm, edited 1 time in total.

Topic Author
John Laurens
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Joined: Mon Nov 14, 2016 7:31 pm

Re: How to handle 529 with full scholarship

Post by John Laurens » Wed Sep 11, 2019 3:19 pm

Thank you for all the suggestions. These definitely give us something to work with.

Regards,
John

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