Military Finances 201: 529 Plan "Leftovers"

Both active and retired Senior Military Officers and NCOs can find themselves in a situation where they have leftover 529 funds. The reasons could be numerous. Maybe GI Bill took care of most the expenses. Or, perhaps the school bills were offset by benefits under the Hazelwood Act. Whatever the reason, you may have funds left in a 529 plan and now you're wondering what to do with them. Here are some options

Change the Beneficiary

You can change the beneficiary of the plan with no tax consequences. However, the new beneficiary has to be a family member. Family members include

• The spouse of the beneficiary
• Children or descendants of the child, parents, ancestors, step parents, nieces or nephews, in-laws (see Code Section 529(c)(3)(C)(ii) for the complete list)
• Spouse of any of the above
• Any first cousin of the beneficiary

Note that the list includes you if the 529 is for your child or grandchild. If an account already exists for a family member, you can roll the funds into the existing account as long as it done within 60 days from taking the money out.

Beneficiary changes can be an effective way to build a legacy for future generations as well. Imagine if you changed the beneficiary from your child to a grandchild and then a great grandchild. You could conceivably have 54 years or more of compounding...all income and estate tax free if used for qualified expenses.

Take the Money Out

You can take the money out, but there is a pretty good chance that taxes and/or penalties can be due. The first thing to note is that penalties and taxes are only assessed on the earnings made inside the 529. The amount contributed is not taxable as it wasn't deducted from income when contributed (this may not be the case at the State level). Secondly, the earnings are included in the beneficiaries income, not yours. If Junior didn't have other earnings, he may not owe taxes on it, but the penalty could still be due. The penalty is a flat 10% of the earnings taken out and not used on qualified expenses.

There are legal ways to avoid the penalty as well (but the exceptions do not apply to the tax due). The penalty will not be assessed if any of the following situations apply:

• The designated beneficiary has passed way
• The designated beneficiary is disabled
• The designated beneficiary attends a US Military Academy (to the extent the distribution does not exceed the costs of education attributable to the school)
• The designated beneficiary received tax-free educational assistance (to the extent of the tax free assistance)
• The distribution is included in gross income because the education expenses were taken into account in determining one of the education credits

The Tax Code is unclear about how closely the distribution must be to the exception. The IRS floated an idea of making it line up with the calendar year plus 3 months, but never followed through. To play it safe, I'd do it the year of.

By the way, if the 529 goes down in value (loses money), you can deduct the loss when you close the account.

Other Things to Consider

As part of the Tax Cuts and Jobs Act, 529 funds can now be used to pay off student loan debt. Other recent changes to the Code also allow 529 funds can be used to pay for K-12 education. So there may be other options out there.

Military Finances are Different

Most Americans don't have access to programs like the GI Bill, Yellow Ribbon Program and the Hazelwood Act, so most financial advisors won't have much insight into how they affect your college funding plans. That's why we think you should work with a financial advisor/planner that deals with military and veteran financial benefits each and every day. If you'd like to chat with us about how we do things, give us a call or click on the button below to schedule a free initial consultation.

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If you found this article useful, you might like the following blog posts:

GI Bill. 529 Funds. Which Should I Use First?

Military Finances 201: Grandpa's 529 Plan and the FAFSA

Do 529 Plans Make Sense for Active or Retired Military Members?