Withdrawal of principal from a 529 plan

[NadCixelsyd]

Just suppose ...

I open a 529 plan for my granddaughter.
In January of 2009-2012 I deposit $10000 per year into this plan, or $40000 total.
It currently is worth $52000, my $40k and $12k have accumulated in dividends and/or appreciation.

I now take out $30k to build an addition on my house. I leave the remaining $22k in the 520 plan. Is this a principal withdrawal, not subject to any tax? -or- is the withdrawal apportioned? -or- is the entire amount taxable?

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[Alan]

On 11/18/13 9:06 AM, NadCixelsyd wrote:
> Just suppose ...
>
> I open a 529 plan for my granddaughter.
> In January of 2009-2012 I deposit $10000 per year into this plan, or $40000 total.
> It currently is worth $52000, my $40k and $12k have accumulated in dividends and/or appreciation.
>
> I now take out $30k to build an addition on my house. I leave the remaining $22k in the 520 plan. Is this a principal withdrawal, not subject to any tax? -or- is the withdrawal apportioned? -or- is the entire amount taxable?
>

Every distribution from a 529 plan includes a return of principal and
earnings on a pro rata basis. The 1099-Q that is received will have the
the piece representing earnings in Box 2. If you don't have any adjusted
qualified education expense to apply to the earnings then they are all
taxable and go on Line 21 of the 1040.
See IRS Pub 970 Chapter 8.

--
Alan
http://taxtopics.net

[NadCixelsyd]

>
> Every distribution from a 529 plan includes a return of principal and
>

> earnings on a pro rata basis. ... (text omitted)

>
> See IRS Pub 970 Chapter 8.
>

OK, that makes sense. But example 1, page 38 doesn't follow that.

In that example, parents contribute $18k to a 529 plan that's now worth $27k. By your statement, one third of any distribution is from earnings. In this example, daughter withdraws $5300 of which the 1099-Q shows that $950 is earnings. Where the hell did they get $950? Why not $1767 (which is 1/3 of $5300)?

[Alan]

On 11/18/13 6:38 PM, NadCixelsyd wrote:
>>
>> Every distribution from a 529 plan includes a return of principal and
>>
>> earnings on a pro rata basis. ... (text omitted)
>>
>> See IRS Pub 970 Chapter 8.
>>
> OK, that makes sense. But example 1, page 38 doesn't follow that.
>
> In that example, parents contribute $18k to a 529 plan that's now worth $27k. By your statement, one third of any distribution is from earnings. In this example, daughter withdraws $5300 of which the 1099-Q shows that $950 is earnings. Where the hell did they get $950? Why not $1767 (which is 1/3 of $5300)?
>

From the Proposed Regs:
======================================================
Earnings attributable to an account are the total account
balance on a particular date minus the investment in the account
as of that date.

Earnings ratio means the amount of earnings allocable to the
account on the last day of the calendar year divided by the total
account balance on the last day of that calendar year. The
earnings ratio is applied to any distribution made during the
calendar year. For purposes of computing the earnings ratio, the
earnings allocable to the account on the last day of the calendar
year and the total account balance on the last day of the
calendar year include all distributions made during the calendar
year and any amounts that have been forfeited from the account
during the calendar year.
========================================================

Then after some tax act changed section 529, the IRS published guidance
in Notice 2001-81.

======================================================
c. Calculation of earnings.
1. In general.
Section 529(c)(3)(A) provides that a distribution from a _ 529 program is
includible in the gross income of the distributee in the manner as
provided under _ 72,to the extent not excluded from gross income under
any other provision of Chapter 1 of the Code. Section 529(c)(3)(D)(iii)
provides that, except to the extent provided by the Secretary, the value
of the contract, income on the contract, and the investment in the
contract are to be computed as of the close of the calendar year.

4. Timing of earnings calculation.
Consistent with � 529(c)(3)(D), the proposed regulations provide that
the earnings portion of any distribution is determined by applying an
earnings ratio, generally the earnings allocable to an account as of the
close of the year divided by the total account balance as of the close
of the calendar year, determined by adding back the amount of all
distributions made during the year. See Prop. Treas. Reg. � 1.529-
1(c). In response to comments received on the proposed regulations, and
consistent with the Secretary�s authority under � 529(c)(3)(D)(iii) to
adopt a different rule, the Treasury Department and the Internal Revenue
Service expect that final regulations will revise the time for
determining the earnings portion of any distribution from a � 529
account. It is expected that final regulations will provide that,
effective for distributions made after December 31, 2002, programs will
be required to determine the earnings portion of each distribution as of
the date of distribution. In the case of direct transfers
between � 529 programs, this requirement is effective for distributions
made after December 31, 2001. In the case of any State program for which
this change would require legislation and whose State legislature has a
biennial legislative session, the program will have until January 1,
2004, to conform to this method of calculating earnings.
===========================================================

So... the Treasury has never published Final Regs. As far as I know,
institutions are stilling using the 2001 Guidance that uses the year-end
values for making the computation.

As to the example in the Pub.... I have no idea. Maybe there is a hidden
assumption that the market collapsed after the distribution and the
year-end earnings were considerably less then on the date of
distribution or maybe whoever came up with the example was using RPN
methodology on an arithmetic calculator.
--
Alan
http://taxtopics.net