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By Theresa Fry, Senior Vice President and Manager, IRA’s and Retirement Planning

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College Refunds and 529 Plans
Recently, colleges and universities have begun issuing partial refunds for spring 2020 semester expenses. With campuses closing to in-person classes and the transition to online learning, more schools may be expected to follow suit.  As a result, many students and parents receiving refund checks have questions about whether these refunds can be put back in to the student’s 529 plan and if it is a good idea to do so. Here are some of the most common questions and answers:

The college is issuing a partial refund for COVID-19 reasons. Can the refund go back into the 529 plan?
If the beneficiary’s school returns money to you, such as a tuition or room and board refund, you can recontribute those funds to the 529 plan within 60 days of the refund without any tax consequences.  The PATH Act added this special rule for 529 plans back in 2015. The amount recontributed to the 529 education savings plan cannot exceed the amount of the refund.

What is the refund for?  Qualified or non-qualified expenses?
If the school is refunding tuition or room and board expenses, then those refunds are for qualified expenses. The school’s online resources will likely provide a breakdown of what is being refunded.  Refunds of qualified education expenses such as tuition, fees, books, supplies, or room and board, can be recontributed to the 529 plan for the student within 60 days tax free. Refunds that are redeposited do not count against the 529 plan’s contribution limits

If any part of the refund is for non-qualified education expenses, any recontribution to the 529 plan would be treated as a new contribution (subject to the annual gift limit of $15,000) and overall plan contributions limits.

Do I have to put the refund back in the 529 plan?
If you originally withdrew from the 529 education savings plan an amount equal to the school’s qualified expenses, and the school is now issuing a partial refund, then this could cause an inadvertent non-qualified withdrawal if you do not have other qualified expenses later in the year. 529 education savings plan withdrawals and expenses are tracked by calendar year (Jan. 1 to Dec. 31).  If, for example, you took a 529 plan withdrawal of $12,000 in January to cover $12,000 of spring semester qualified expenses and the school issues a refund of $2,000, by redepositing the refund within 60 days you are adjusting your qualified 529 plan withdrawals to $10,000 to match the amount of adjusted qualified expenses. If the student will not have additional qualified education expenses this year, then adjusting your withdrawal by redepositing the refund would be necessary to avoid a $2,000 non-qualified withdrawal.

If the 529 plan withdrawal was not for 100% of the original qualified education expenses, you may not need to redeposit the refund from the school.  For example, let’s say you took a $10,000 withdrawal in January to cover $12,000 of spring semester qualified education expenses. If the school now refunds $2,000, you still have a $10,000 qualified tax-free 529 plan withdrawal covering $10,000 of qualified education expenses and may want to keep it. However, if the school refunds $3,000, then you have $1,000 more in 529 withdrawals than you have in qualified 529 education expenses. In that case, to avoid having a $1,000 non-qualified distribution (taxes and a 10% penalty on the earnings), redepositing $1,000 of the $3,000 refund is all that would be required to avoid a non-qualified withdrawal, unless there are additional qualified education expenses this year.

If it has been more than 60 days since the refund was issued by the school, the income tax treatment for putting the refund back in the 529 plan is different. Any deposit of the refunded amount would be treated as a current contribution (subject to the $15,000 gift limit and plan contribution limits). Outside of the 60-day window, you need to compare your 529 plan withdrawals to your adjusted qualified education expenses. If 100% of the qualified education expenses were paid from the 529 plan and the school has issued a refund of some of the qualified expenses, using the refund to make a new contribution outside of the 60-day window doesn’t eliminate the non-qualified withdrawal that results from the school adjusting its qualified expenses. Using the same example as above, if the school refunds $2,000 of the $12,000 expenses paid by the 529 plan, but the recontribution is not made within 60 days, you could end up with a $2,000 non-qualified withdrawal which would make earnings subject to income taxes and a 10% penalty and could also cause state income tax deductions to be recaptured.

Can I use the refund for fall semester expenses?
If the student will be continuing in the summer or fall and will have additional expenses in 2020, you may want to keep the refund and use it to offset future expenses instead of redepositing the refund and reinvesting it now.

Is now a good time to be reinvesting the refund?
If recontributing the refund is an option for you, but not necessary to avoid a non-qualified 529 withdrawal, consider carefully whether now is a good time to be reinvesting in the 529 plan. For students currently enrolled who may be nearing the end of their educational expenses, reinvesting now during volatile markets may not make the best use of the tax-deferred benefits that a 529 savings plan offers since the investment may be short-term.

 

DISCLAIMER
The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards & Co. does not provide legal or tax advice, therefore it is also important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.

April 20, 2020 |