Frequently asked questions about 529 plans
What's this I hear about a penalty
on refunds? What happens if my child doesn't go to college or if
I simply end up with more in the account than he needs for college?
Federal law imposes a 10% penalty on earnings for non-qualified
distributions beginning in 2002. The penalty is not assessed on
principal. An exception to the penalty can be claimed if you terminate
the account because the beneficiary has died or is disabled, or
if you withdraw funds not needed for college because the beneficiary
has received a scholarship. You can change the beneficiary to another
qualifying family member at any time in order to keep the account
going and avoid (or at least delay) taking non-qualified withdrawals
when the original beneficiary doesn't need those funds.
That penalty doesn't sound so
bad. Am I missing something?
What could be worse than the penalty is the fact that the earnings
portion of a non-qualified distribution that comes back to you,
the account owner, will be subject to tax as ordinary income at
your tax rate. (Some 529 plans allow you to direct the withdrawal
to the beneficiary, which would presumably keep it in a low tax
bracket.) In addition, if you were able to deduct your original
contributions on your state income tax return, you will generally
have to report additional state "recapture" income.
Why do you keep saying "generally"?
Assuming you are not questioning my grammar, the answer is that
for almost every generality discussed you can find at least one
state that does things differently. Some states do have age restrictions.
Some states do not allow rollovers to any member of the family at
any time. Some states do give the beneficiary certain rights. Some
states do not allow you to be the beneficiary of your own account.
Can I transfer my existing Coverdell
education savings accounts and U.S. savings bonds into a 529 plan?
Yes, you can accomplish these transfers without
triggering tax, but you should be careful about
ownership issues. For instance, the Coverdell ESA
(formerly the Education IRA) is effectively owned
by your child and so it may not be proper to transfer
the funds into a 529 account that is owned by you.
Also note that the tax-free transfer of U.S. savings
bond redemption proceeds into a 529 plan requires
that you meet all the qualification requirements
for the education exclusion, including the income
limits in the year of the redemption.