529 Plan distributions to other than the designated beneficiary

[Mike12321]

Taxpayer took distribution from a 529 plan originally set up for his son but took a distribution to pay for his wife and daughter's higher edu expenses.

Can the wife be designated the beneficiary, or are the earnings just subject to tax plus the 10% penalty?

[Skylane · Accepted solution]

May be a little later for last year but...…….

https://www.savingforcollege.com/article/how-to-transfer-529-plan-funds-to-a-sibling

[Mike12321]

Great answer! The article states that distributions can only be used to pay for one child's expenses. Also, if distributions are used to pay expenses of anyone other than the designated beneficiary they are subject to income tax plus the 10% penalty, and possibly recapture of state tax benefits.

The other issue I struggled with was segregating the education expenses paid with the 529 plan from those used for the AOC. However, I found that you designate the expenses used for the credit, and then the surplus can flow to the 529 plan distribution on the qualified expenses page.

Then comes the exception to the 10% penalty if the reason for not applying the 529 plan distribution is taking the credit. That is a lot of work to deal with a 529 plan distribution!

In the case of my question, they do have to pay the extra penalty however.

Thanks!!

[Terry53029]

Did the beneficiary have a scholarship, if so there is an exception to the 10% penalty

Exception #2 – The beneficiary receives a scholarship(s)

If the beneficiary receives a tax-free scholarship or grant the account owner can withdraw up to the amount of the award without paying the additional 10% penalty. What this does is changes the 529 account from a tax-free investment, to a tax-deferred investment

[Mike12321]

Thanks for your comment. I was reviewing this situation today, and saw that I could avoid the 10% penalty tax if the reason was the qualified expenses were used for the AOC. The software seemed to calculate and divide the amount of earnings between the two lines, one amount for tax fee scholarships and the other for the AOC on the 5329 form. 

I had tried to enter on the 99-Q form the amount used for the AOC, but it kept disappearing. I guess you enter that on the form 5329 in the smart box. However, it looked like the software was making a calculation, so I just decided to rely on it.

I saw at the bottom of the page where on the form were adjusted qualified expenses are figured where you enter the amount for the expense applied to the 529 plan for income tax and the 10% penalty. I put zero in the tax column and the software did put a figure in the 10% column, so I just thought it knew what it was doing. I will go back and check again.