Germany/USA - What to do with a 529 plan

[naijaboy17]

I am an American living overseas (in Germany) and my children are now preparing to enter university. They will be going to universities outside of USA and are not on the FAFSA list of qualifying schools. This means their expenses are not eligible for 529 plans. I am trying to find the best way to use these funds with the least tax impact. These are the options I’ve thought of so far:

1) Send the money to myself and give it to the kids. This will show up as US sourced taxable income for me. IRS will want me to pay income tax and 10% penalty. I am in one of the higher tax brackets (e.g. 32%) and while I take the foreign tax credit to zero out my US tax liabilities, a) I think this would be counted as passive income and is US sourced so I cannot use my foreign tax carryover, and b) I assume this money would be taxed at the highest percentage. 32% + 10% penalty for ineligible 529 withdrawal will mean 42% tax on the earnings & interest in the 529. Ouch.

2) Send the money to my kids directly. They would be in a low tax bracket - e.g. 10% and would have to pay 10% income tax + 10% penalty tax, so 20% together, half of what I would have to pay

On top of all of this, Germany would also want to tax the interest, at 25%. I’m not even sure how to prevent being double taxed on this if it comes to one of us German residents directly. So to avoid German taxation, the other two ideas are:

3) Change the beneficiary of the plans to a family member (e.g. cousin) who will be going to college, in exchange for them / parents sending me an equivalent amount of money directly. I think this would be tax free in this case.? Although I would probably need to give them something to make it worth their while - e.g. $1000 ..

4) Give the account to my parents and let them withdraw the money to themselves, and pay the university. They are in a lower tax bracket than me and so while there still might be 30% tax, it would be less than if I did it, and I would avoid having to include this on my German tax return.

The 529 plan company itself has said they will not give me any advice on this situation unfortunately, and I so far have not found other consultants knowledgable on these types of cross border issues.

Can you think of better ideas?

 

[resjudicata]

@naijaboy17 Just as an FYI, changing the beneficiary to anyone but your children triggers gift tax in Germany. You've got a freebie of 400k EUR to your children (each), but only 20k to anybody else. The counter resets every 10 years. So option 3 and 4 are also not advisable.

You really want to speak to a tax planner here familiar with both legislations, that's not an easy fix.

 

[naijaboy17]

@resjudicata Thanks for pointing that out. I hadn't considered that.

I haven't yet found such a tax planner who really understands the Germany-USA tax treaty and how to take specific actions in each country . I've been looking for this and would gladly pay an hourly consulting fee for this but all the American based companies I talk to have no real knowledge of German tax rules and I haven't found a German tax advisor who also understands the American rules yet, although I'm still looking..

 

[stephendisraeli]

@naijaboy17

but all the American based companies I talk to have no real knowledge of German tax rules
I haven't found a German tax advisor who also understands the American rules yet,

Welcome to the dumpster fire that is international taxation.

Chances are that if you manage to find someone who knows both tax codes and the relevant tax treaties (*1), you will find that such services are geared to companies and wealthy individuals and priced accordingly.

(*1) There are several! There's a tax treaty, a gift and estate tax treaty, and a totalization agreement.

Good luck.

 

[mmarco]

@naijaboy17 Are you sure the foreign institutions are not on the list? The list is very extensive in Europe, in particular Germany.

 

[emily120709]

@naijaboy17 Hahaha...tax law is so much fun.

Fuck. This sucks. I'm sorry.

 

[trantrang2461]

@naijaboy17

Change the beneficiary of the plans to a family member (e.g. cousin) who will be going to college, in exchange for them / parents sending me an equivalent amount of money directly. I think this would be tax free in this case.?

This sounds like quid-pro-quo aka most likely viewed by the IRS as the same as you simply withdrawing the money yourself should they find out (though tbh in reality it seems like it would be unlikely that they would). Not a good plan.

Send the money to my kids directly. They would be in a low tax bracket - e.g. 10% and would have to pay 10% income tax + 10% penalty tax, so 20% together, half of what I would have to pay
On top of all of this, Germany would also want to tax the interest, at 25%. I’m not even sure how to prevent being double taxed on this if it comes to one of us German residents directly.

I believe in this case your kids would only pay the 25% tax, right? They would take the FTC on that money and the 25% paid to Germany would cancel out the US taxes. imho this is a pretty reasonable option, as long as they're living in Germany this is the lowest tax % they could possibly get this money for. You lose the 529 benefits so this is basically equivalent to if you lived in Germany the whole time and saved for your kids education via a standard brokerage (the only option here since there are no tax-advantaged accounts like in the US), then gave them the money

 

[naijaboy17]

@trantrang2461 My understanding of the FTC is it only applies to foreign sourced income. In this case, the 529 gains would be US sourced and I couldn't use the FTC for it. If I could, I would do that for myself as I already have a FTC carryover from previous years.

 

[trantrang2461]

@naijaboy17 I think you're describing the FEIE. You can definitely apply the FTC to US sourced gains, as long as you paid non-US taxes on it, though you should ask an accountant to be sure.

 

[stephendisraeli]

@naijaboy17

My understanding of the FTC is it only applies to foreign sourced income.

Tax treaties sometimes contain re-sourcing provisions that can change the source for taxation purposes to mitigate some of the double taxation via tax credits.

 

[tlwilnos]

@naijaboy17 With the passage of SECURE 2.0, you can now start to transfer the money in a 529 to a Roth IRA (max $35,000 and $6,500 per year). It doesn't really help with their immediate education expenses, but they can get set up for a good retirement.

 

[cobes1128]

@tlwilnos This is only helpful if they have US taxable income, right? Even with Secure 2.0, there has to be earned income to be eligible for the Roth transfer - or am I wrong on that?

 

[tlwilnos]

@cobes1128 They would need to earn money (and almost any they earn would be taxable) in order to do the rollover (rollovers count against the annual IRA contribution limit and are limited to $7,000/year.)

 

[cobes1128]

@naijaboy17 To OP... did you find a solution on this?

 

[ababwaalijaz]

@cobes1128 +1