529 Distribution Direct to Child for Personal Use / Savings

Forum|Forum|4 years ago
October 3, 2021
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Due to a change in circumstances, I may be in the position where I have overfunded my kids' 529 accounts. Assume that retaining the funds and changing the beneficiary to future grandchildren is not under consideration. If so, what are the consequences of making distributions to them in an amount that generates taxable income below the filing threshold? I think that amount is 12,400, but the specific number is not immediately relevant. So if the income component of the distribution were less than that, would they have to pay any income tax on the distribution? Presumably not, but the 10% penalty is still an issue, isn't it? So in this case it would be possible to distribute 529 proceeds to kids, with the result being an effective tax rate of 10%. Is that right? If so, it would seem an effective way to avoid paying higher rates with respect to future distributions of this sort when there is income from other sources that will push up the effective tax rate.

Does this make sense?

Thoughts welcome!

Hal_Al

Employee

Q. Does this make sense?

A. Yes, if the the beneficiary is not your dependent or a full time student under 24.

Q. If so, what are the consequences of making distributions to them in an amount that generates taxable income below the filing threshold? I think that amount is 12,400.

A. The taxable portion of a 529 distribution is "unearned income". The filing threshold is $1100 for dependents (and full time students under 24) with unearned income. Any income over $1100 is subject to income tax well as the 10% penalty.

But only the earnings portion of the 529 distribution is subject to tax and penalty. The fist $1100 (of earnings) is tax free (but not penalty free). The next $1100 is taxed at the student's rate, usually 10%. The amount over $2200 is taxed at the parent's marginal tax rate (the "kiddie tax"). The kiddie tax does not apply if the dependent is over 18 and not a full time student.

Curious OneAuthor

Thank you for clarifying the character of the income and the thresholds pertaining to unearned income of a minor. All of the kids are currently my dependents, but one of them is 19 and another will be 18 in March.

The 19 year old is P/T student, and will likely remain that way for the foreseeable future. So for him the first 1100 would be at the 10% penalty. The next 1100 would be at 10+10 for tax rate attributable to unearned income plus penalty. What are the marginal rates above 2200?

The to be 18 year old is a senior in HS and come next fall will almost certainly be a F/T student somewhere. Can I do anything with her at this point as she's only 17? Or come next March when she turns 18 even though I fully expect her to be a F/T student in college in the fall?

My youngest is 15 and a freshman in HS. I gather there's nothing I can for her at this time.

Thanks again for your further input.

Hal_Al

Employee

The 10% tax rate in on the the first $9950 above $1100. Then 12% on the next $30575 and 22% over that.

Tax brackets: https://www.forbes.com/advisor/taxes/taxes-federal-income-tax-bracket/

Q. Can I do anything with the 17 or 18 year old senior in HS or future FT student over 18?

A. No, all 3 (17, 18 or FTS 19-23) are subject to the kiddie tax.

Q. My youngest is 15 and a freshman in HS. I gather there's nothing I can for her at this time?

A. Correct. The 15 y.o. is also subject to the kiddie tax

The 10% penalty is waived on the portion of a 529 plan distribution equal to student scholarships or amounts the parent uses to claim a tuition credit.