Qualified 529 Plan distributions.
My client has contributed $39,000 to a state qualified 529 Plan over the years. College begins next year 2009. The investments have lost considerable value and are now worth $38,000. The client wants to apply for student parent loan through the govenment and use forbarance for 4 years to give the investments time to earn back what they have lost. I am reading IRS publication 970 pg.49 and I’m still not clear if there is a way to use the 529 funds to pay off the student loans upon graduation. Can you simply have the funds sent to you (to pay the loans) and provide the IRS with an itemized statement of all normaly qualified higher education expenses over the 4 years?
Permalink Submitted by BruceM on Wed, 2008-12-03 22:15
Apparently not.
Although Pub 970 doesn’t specify timing, it appears that the IRS considers qualified Ed Expenses those that occur in a given year, not in past years.
Take a look at the ‘Savingforcollege’ web site where this question is addressed…
http://www.savingforcollege.com/bankrate_articles/article.php?article_id=40.
But even if qualified 529 plan withdrawals could be made for past year’s QEE’s, I’m not sure your strategy would be a good one. The PLUS loan will be incurring interest expenses that may exceed future investment gains.
BruceM
Permalink Submitted by Alan Spross on Wed, 2008-12-03 23:27
Bruce is correct.
This is quite logical when you consider that there are education credits such as the Hope or Lifetime Learning Credits that can be claimed for qualified higher education costs funded by student loan proceeds.
The various education tax benefits are overly complex as is, but isolating loan repayments to the student loan interest deduction prevents the need for tracing rules to determine over a period of years how much of the loan repayment represents costs that never received a credit for the year of actual payment of those costs. This would be necessary under the various double dipping restrictions. The result is that taxpayer gets tax credits for the year expenses are actually paid, and then if a loan provided those proceeds, the student loan interest deduction is the only tax benefit directly connected to repayment of the loan.
Client could still withdraw the 529 funds tax free since there are no earnings and apply them to the education or anything else. The current loss of 1,000 could be a misc itemized deduction if the entire 529 plan was terminated, but with the 2% AGI floor, this would probably not amount to any benefit. Another option would be to change the beneficiary on the plan if family circumstances warrant and the education costs would be incurred after some tax free earnings generation.