Avoiding a 529 Penalty When You Receive a Refund
By Joe Messinger, CFP®
April 16, 2020
Parents can use money from a 529 college savings plan to pay for qualified higher education expenses like tuition, room, and board. When used for those purposes, the money earns interest tax free. If the money is not used for a qualified college expense, the account owner is subject to income taxes plus a 10% penalty fee on the gains you earned. Usually colleges are not refunding money back to a family (unless a course is dropped). However in these times of COVID-19, many colleges are refunding pro-rated room and board funds back to families. If you used a 529 plan to pay for these amounts, what can you do to avoid a 529 penalty?
The first option is to use the money for an upcoming qualified expense during the same calendar year.
If you received a refund during this spring semester, use that money for tuition (or room and board, etc.) in the fall. However, watch that calendar. If you received the money in 2020, you must spend it before 1/1/2021.
Another option is to recontribute the money back into your 529 plan.
Each plan will be a bit different so visit their website for accurate instructions. (Here are the specifics from Ohio’s 529 Advantage plan.) In general though, this recontribution MUST occur within 60 days of issuance of the refund (not the day you received the refund–the date the refund was issued).
You, the account owner, must send in a check to the 529 plan for the refunded/recontributed amount. By sending a check, you have a nice and neat paper trail for tax purposes.
You will need to include a letter of instruction for the folks at the 529 saying that this check is a recontribution of refunded 529 money used to pay for qualified expenses earlier in the year and not a new deposit. A good practice would be to include as many details in the letter as possible: the amount being recontributed, when was the refund issued, and the name of the institution.
On both the check and in the letter, be sure to include your child’s name and account number.
Be sure to save all receipts.
You will have to provide a paper trail of how the money was spent or re-contributed if a question arises with the IRS. Be sure to consult a tax professional if you need additional personal guidance regarding tax implications.
A few extra steps can protect you from an unexpected 529 penalty.
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