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#17307 - 04/07/03 04:03 PM Children receive 1099-R & contribute to Sec 529
kccpa Offline
Junior Member

Registered: 04/07/03
Posts: 3
I have a taxpayer who received a 1099-R distribtion froma pension (code 4 - death). In addition, his two children received a 1099-R pension distribution of about $74K. The children each contributed to a 529 Plan...I don not have the amount of the contribution yet. The ages of the children are 12 & 14 for the kids at the date of distribution in 2002.

Since the kids made the contributions themselves what and how is this reflected on their tax returns?

I admit to not dealing with Sec 529 Plans...as this is my first so I would greatly appreciate some guidance.

Thanks in advance!

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#17308 - 04/07/03 04:25 PM Re: Children receive 1099-R & contribute to Sec 529
Dopps Online   content
Member

Registered: 01/23/02
Posts: 1348
Loc: Chicago area
There is NO Federal deduction for 529 contributions. Most states allow for a State income deduction, but only if a resident contributed to their home state's 529 plan. Check the laws of the kids' home state to see if they get the deduction for their contributions. If so, further check to see if the deduction is unlimited (thus equal to their contribution) or subject to annual maximums.

The kids, being minors, probably have an adult as the 529 account owner. But, the deduction belongs to the kids, since it is their money that was contributed. This makes any dedection probably not worth a lot, unless the kids have income (passive or otherwise).

[This message has been edited by Dopps (edited April 07, 2003).]

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#17309 - 04/08/03 11:16 AM Re: Children receive 1099-R & contribute to Sec 529
Drewparr Offline
Member

Registered: 03/25/03
Posts: 511
The kids transfers of their money into accounts where they were named as the beneficiary is a non tax matter, its not a gift, its to oneself as a matter of Sec 529.


HOWEVER the question of plan ownership can be very important as to any college financial aid issues. In short, if the kids own the plan outright or via a trust, said assets can be essentially fatal to any other college financial aid, and "taxed" by system rules in excess of 100% if left in place. Ditto for any assets in kids name or trust for kid. IE your old UTMA or UGMA is sure to be fatal.

If aid is not an issue then there is no ownership issue.

There are many grey areas of state law as to how to undue this problem (if necessary) I would strongly suggest that one move asset ownerships out of harms way to the extent that ones conscience and legal counsel permit. In some cases ignorance would seem to be an advantage.

EG a 529 for kids "owned" by Uncle XX is NOT an asset counted against aid in any current context under FAFSA. Its actual distribution may count against future aid--but one can step thru or defer that impact.

You need to assess the financial aid impact and the higher education likley needs.

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#17310 - 04/08/03 12:22 PM Re: Children receive 1099-R & contribute to Sec 529
advisu Offline
Member

Registered: 10/16/01
Posts: 174
Loc: Centerville,MA
kccpa

This illustrates the problems that a surviving parent can face with improper planning during a parents lifetime.

This is not to say that there was not proper planning, however too often I have seen this type of problem occur with respect to beneficiary designations on retirement accounts, life insurance etc.

Well meaning parents will often name a child a beneficiary of the accounts or insurance policies without realizing the impact that it can have on ones ability to receive financial aid.

I have met several times with a surviving spouse who had minimal wages, were not prepared for their own retirement, had trouble making ends meet but would not have been eligible for needs based financial aid due to the children having been made beneficiaries of their deceased parents accounts.

It is also not uncommon to see a surviving spouse who received 100% of the proceeds who in turn receives "advice" to transfer a portion of the proceeds to a child or invest it in a 529 plan, insurance policy or annuity. Any of these options might have negative affects on taxes, financial aid, cash flow or a combination of all three.

The right planning prior to death and before investing will provide the best results.

In order to provide a better response to your question you might wish to provide a more complete profile of your client. Income, assets, age, tax bracket, specific education goals etc.

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#17311 - 04/08/03 06:50 PM Re: Children receive 1099-R & contribute to Sec 529
kccpa Offline
Junior Member

Registered: 04/07/03
Posts: 3
It seems to me that the parents either received bogus advice or they just don't understand the ramifications of what they did.

The kids received a pension distrib of $74K with taxes taken out...remainder is somewhere in $53K range. That amount was contributed to various Sec 529 accts.

The parents indicated to me first that the entire amount was rolled over. Can't be since taxes were taken out. Now, from what I can determine, they will have to pay tax on the entire $74K distribution as the "rollover" of the net amount into the Sec 529 plan does not have any tax implications.

Am I missing something here? Does anyone see any suggestions for the parents since this event ocurred in 2002?

I doubt that they visited a professional before making this decision. I'd like to be able to offer them a solution to this problem...can anyone help?

Thanks again!

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#17312 - 04/09/03 09:21 AM Re: Children receive 1099-R & contribute to Sec 529
Drewparr Offline
Member

Registered: 03/25/03
Posts: 511
1. A 529 must be funded with cash, so unless some exception applies as to the pension distribution, the distribution from the pension is a taxable event. There may have been some time spread distribution options but now that appears to be water over the dam. In short I think they are stuck with taxes on the pension distribution. The 529 per se is not sheltered in any rollover context (save a conversion from a Coverdell account or some forms of Seried E savings bonds which protects that form of a rollover but its still done in cash)


2. What I am suggesting is to take a look at the financial aid prospects/issues and how the 529(s) is/are titled / owned. If the kids own it, its fatal. If the parents own it, it is much less of an impact, perhaps none, and if somebody else is the nominal owner it may not count as an asset at all. There are a number of ways to spend down a kids assets which appear to be within the law (and replace them with new assets held otherwise more favorably) and in my lay opinion a number of ways to shift titles that fall into grey areas of the law very unlikley to be examined if the outcome for the kids is actually carried out. (I am not suggesting that parents can pocket the money!)
There is essentially no tax penality to unwrap a 529--except a normal income tax on any gain portion and a 10% penality on such gains--ergo little or no gain= little or no penality.

A stubbornly held 529 can result in about a 140% tax if aid would otherwise be in the picture. We're missing that part of the question?

PS, if the kids didn't put it all into a 529 plan then that excess also needs to be out of the picture when it comes time for FAFSA applications.

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#17313 - 04/09/03 01:59 PM Re: Children receive 1099-R & contribute to Sec 529
kccpa Offline
Junior Member

Registered: 04/07/03
Posts: 3
Thanks to all.

It looks like all my questions have been pretty much answered. In essense, they are toast. Their "financial planner" from the college fund folks had them take the net left after cashing in the 1099-R and roll that amount into various 529 plans. The kids, age 14 & 12 now have to pick the entire $74K as income...although they deposited about $52K into the 529's.

The child of 12 now has kiddie tax issues and owes a substantial amount of tax.

Oh, the client is going to be happy about their tax returns...NOT!

Unfortunately, they did not seek a tax professional before embarking upon their decisions.

The ownership of the 529 plans belong to the kids (i.e. funded with the children's money alone - the net received from the 1099-R distribution).

Whether they would have qualified for scholarship...not sure. The parents income is iffy. They are currently making too much for the kids to qualify.

Thanks again to all.

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#17314 - 04/09/03 02:51 PM Re: Children receive 1099-R & contribute to Sec 529
advisu Offline
Member

Registered: 10/16/01
Posts: 174
Loc: Centerville,MA
KCCPA

Based upon the actions that your client made the older child will now lose out on $26,885 in financial aid as a college Freshman. He will also lose out in subsequent years. The younger child will lose aid of $30,781 as a Freshman. (assuming a 7% annual return)

This was a very expensive lesson! Both from a loss of financial aid and an increase in taxes. This example illustrates what can happen when one chooses not to hire competant tax and college planning advice.

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