A COVID-Related Refund & Your 529 Distribution

We all have them, a friend that never picks up the check when out for drinks or dinner. You know the type, they might pretend to reach for their wallet, but it is just for show. If you are in south Florida, it is called alligator arms – their arms are too short to reach their wallet. After a while, it is a given – you don’t expect any money from them.

The same holds true for colleges and universities. How often have they given you money back? It took a pandemic, but many students are now receiving a refund from their school.

With all the stress and drama of COVID, one overlooked issue is what to do with the 529 Plan distribution. 529 Plans are used for higher-education funding. If used for qualified education expenses, the distributions are tax and penalty free.

If not used for qualified education expenses, any earnings (not contributions) are taxed as ordinary income, along with a 10% penalty. It is considered a non-qualified distribution. With the recent COVID-related refunds, many families don’t have the required education expenses to make their 529 distributions qualified.

Here are some possible options to avoid the 529 taxman:

  • Find another qualified expense
    • The list of qualified expenses for 529 plans is large, much larger than other education-related accounts.
      1. If you don’t have enough room and board or tuition, how about a new computer, software, or internet access used for remote learning.
  • Put it back (by the account owner, not the student – usually the parent)
    • Generally, you have 60 days to put the funds back into your 529 plan
      • It is from the date of the refund, not the date the check was received
    • Contact your 529 Plan sponsor to get details and instructions to make sure it is coded correctly
    • Be careful what you invest in when going back in!
    • Keep detailed records for the IRS
  • Use it for the fall semester (if they have one)
    • Most families will take 529 funds out as they need them. If you took funds out for the Spring 2020 semester, just save them for the Fall 2020 semester
    • Make sure to redo your plan for investments and distributions

We are all struggling with the sudden challenges COVID has forced upon us and the last thing families need is to have an unexpected 529 tax and penalty. Plan a little time to review your 529 plan and make sure you don’t add any unneeded stress.

Stay safe, stay well, and try to find beauty even in these strange times.