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A 529 trick for expats

Any day that you find a way to legally protect investment dollars from the tax man is a good day! The 529 college savings funds have provided many good days for a lot of people over the years because any growth in your investments will not be taxed in the USA.

There are some normal cautions that always go with a 529, such as to be sure to move your funds to a safer money market type investment 3-5 years before the funds are needed (lest a market downturn hit when you are forced to remove your money), to be sure to withdraw funds in the same calendar year that payments are made to the qualified educational institution (payments made in December for January classes, need to be removed from your 529 before the end of December), and so on.

The Foreign Tax Problem

Argh!

An additional caution is in order, however, for expats who are paying income taxes abroad. To your foreign tax authority, your withdrawal – which results in a 1099-Q tax form – will look very much like a normal form of income. Just because the US government considers your 529 withdrawal to be tax-free if used for educational expenses for a qualified school, doesn’t mean your country of tax residence will see it that way. Some financial experts have gotten wind of this possibility and have begun to discourage missionaries and nonprofit workers from using this nice 529 tax-avoidance vehicle.

The Expat Solution

There does appear to be a simple solution, however. To be honest, I ran into this solution entirely by accident and only later saw the benefit in it. Every 529 has an owner (usually the parent that funded it) and a beneficiary (usually the daughter or son) who is going to college. The parent will instruct the financial institution managing the 529 to pay out the money. The trick is in who receives the money.

Since I am the one paying my child’s bills, it seems logical that I would request the funds to be paid into my checking account. At the end of the year, a 1099-Q will be issued in my name. That might present a problem for me if I’m paying income tax abroad.

However, there is no law that prohibits you from having the funds paid out to the beneficiary of the 529. When you log in to your financial institution’s website to make a withdrawal it will usually list your son or daughter as a possible recipient of the funds right alongside your own name. Distributing the funds in this way results in a 1099-Q being issued in his or her name and not yours. It does not need to be reported to your foreign tax authority.

Assuming your child is paying taxes in the USA and the funds were spent on appropriate expenses, the 1099-Q will not result in any taxes due from your child and may not even need to be reported on her or his taxes.

It is nice to have an easy solution to an expat problem for a change.

This post was written for VagabondFinances by our frequent contributor, Michael A. Carlson.  

Michael A. Carlson

Michael A. Carlson

I have a passion for introducing Europeans to Jesus, starting churches of any shape or size, teaching, writing, and training. I also love to equip Europeans and missionaries through my websites such as MissionePerTe.it and QuestionsForChurchPlanters.com.

2 thoughts on “A 529 trick for expats

  • 7 April 2018 at 11:13
    Permalink

    How about paying the funds out directly to the educational institution? 529 plans do that, too, and it avoids the possibility of any mishandling by you or your son/daughter. Since the account at the school is in your child’s name, that will serve the same purpose you mention, i.e. your child will get the 1099-Q not you.

    • 7 April 2018 at 17:44
      Permalink

      Sure you can, Jim. Good idea and question. There are a lot of moving parts here, so what I suggested above seems the easiest for most expats if they run the risk of the 529 withdrawal being taxed. In addition to my trick of sending the money to the kiddo, I think there are two more options:
      (1) Send the money directly to the institution as you said: However, that doesn’t help when covering the costs of expenses like a computer, school books, supplies, etc. On occasion, some colleges have reduced financial aid when the 529 monies are given directly to the school. SavingForCollege.com says, “You would not want the school viewing the 529 money the same way it views a scholarship and reducing your child’s financial-aid package. Check with the school first…”
      (2) I believe you can transfer the ownership of the 529 to a grandparent, leave your son or daughter as the beneficiary, and ask the grandparents to take the distribution. That seems to overcomplicate things.
      Additionally, everyone should remember to calculate the interplay between the American Opportunity tax credit and their 529 distributions. You probably don’t want to take such a large 529 distribution that you lose the AO tax credit.
      Thanks, Jim, for your good question and for making the very first comment on VagabondFinances.

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