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A Tale of 2 Mistakes

Posted: 2014-01-30

by Joseph Hurley

A Tale of 2 Mistakes

Financial Professional Content

Mistakes happen. When your clients make mistakes, there may or may not be much they can do to fix them. Let's look at two common mistakes dealing with 529 plans. The first is taking a distribution from a 529 plan when you don't mean to. The second is forgetting to file the 5-year election on large contributions to a 529 plan.

Mistake #1: Taking a distribution from a 529 plan when you don't mean to.

This mistake happens when your clients withdraw 529 money to pay the current semester's tuition bill, and the next day their child announces he is taking a year off from school to travel around Europe.

Or it happens when they receive the distribution on December 30 but don't get around to paying the tuition bill until January 3.

Or it happens when they inadvertently press the "total withdrawal" button on the 529 website when they meant to press the "partial withdrawal" button.

Or it happens when daughter Sally is the one in college but they take the withdrawal from son Johnny's 529 account.

In any of these situations, your clients cannot just return the money to the 529 plan. If they do, the plan will treat it as a new contribution—not as the reversal of the prior distribution. The withdrawal will still generate a Form 1099 that gets sent to both the taxpayer and to the IRS.

The barn door closed as soon as the horse left.

The potential fix to this problem is to roll over the withdrawn funds (or some portion of them) to another 529 plan. But your clients have only 60 days from the date of withdrawal to do this.

If they happen to still be within the 60-day window, they should thank their lucky stars. They just have to be sure to roll over to a different state's 529 plan if keeping the same beneficiary on the account. (They can go back into their existing 529 plan only if they are changing the beneficiary to another family member.)

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