Careful Planning for College Refunds – Avoiding Tax on 529 Distributions
Due to their tax-advantaged nature, 529 college savings plans have quickly become one of the most popular ways for families and individuals in the United States to set money aside for college. These accounts offer special income tax deductions in many states for those that contribute to a 529, and any growth from investments within the accounts it federally tax-free when used for qualified education expenses. Unfortunately, if you took a distribution from a 529 account in 2020, you may be at risk of unintended tax consequences if you do not take action soon.
As a result of the COVID-19 outbreak and subsequent shut down of colleges and universities across the country, many institutions have issued refunds for tuition, fees, room, and board, etc. In the eyes of the IRS, if you took money out of a 529 plan to pay for qualified college expenses, and that money was refunded to you, then the refunded amount is no longer considered a qualified distribution. Losing the qualified distribution status means that this refund could be fully or partially taxable to you.
The good news is there are still steps that can be taken to maintain the tax-advantaged status of this hard-earned money. Your options are:
1. The refund can be spent on newly qualified education expenses before the end of the calendar year – This may be the easiest solution for students that will need to cover expenses incurred for the summer or fall terms.
2. Re-contribute the refund to the 529 account – Typically, you have 60 days from the date a refund is received to re-contribute the money to your 529 account; however as a result of the CARES legislation, refunds made on or after February 1, 2020, and prior to May 16, 2020, may be re-contributed to the 529 by July 15, 2020.
If you took a distribution from a 529 account, you should review your account with the college or university to ensure that you are aware of any refunds that you may have received. If any refund was received, keep good records on either the newly qualified expenses that the refund was used to cover, or records that you properly followed your 529 provider’s procedures for re-contributing assets to the 529 account. If you received a refund for qualified education expenses and have questions, please reach out to your BDF team.
Charlie Murin is a Wealth Manager at BDF. He is an active member of the firm’s Financial Planning Committee which is responsible for developing and improving the firm’s multifaceted planning process. Charlie earned a Bachelor of Science from the University of Illinois in Consumer Economics with a concentration in Financial Planning. He has his Series 65 license and is a CERTIFIED FINANCIAL PLANNER™ professional.