With most colleges and universities closing dormitories and cafeterias and sending kids home for the remainder of the school year, many are now sending refunds for room and board. This could present a potential tax risk for those expenses that were paid for from distributions from a 529 college savings plan.
In order for a distribution from a 529 plan to be tax free, it must be a qualified distribution. A qualified distribution is required to be used to pay college-related expenses, including tuition and fees along with room and board. And, since refunded amounts are no longer considered qualified educational expenses, the IRS could recharacterize them as non-qualified subject to a 10% penalty and income tax on the earnings portion of the distribution. Depending on the total refund from the college or university, this could be a relatively immaterial amount. However, each situation is different.
529 Withdrawal Timing
When you pay college-related expenses, you must make 529 Plan withdrawals in the same year. The calendar year issue gets tricky during winter semester, which begins after January 1st. So, the question is, when was the 529 withdrawal for the Spring semester? If the withdrawal was made in 2019 then you most likely need to recontribute the refunded amount into the 529 plan. If the withdrawal was done in 2020 then you could use the refund for the upcoming fall semester and not have to re-contribute the refund. TWP Tip: It’s complicated, talk to your financial advisor.
Document the Recontribution
First, call the 529 plan provider and ask for their specific requirements. If you plan to make a recontribution write a check. Attach a detailed letter explaining that you want the contribution to be characterized as a recontribution of a prior qualified withdrawal rather than a contribution. State that you are making the recontribution within 60 days of receiving the refund. And lastly, note the date when the original 529 withdrawal was made.
At Total Wealth Planning, as part of our comprehensive approach to financial planning, we work with families to determine the best strategies to pay for college by taking into consideration the family’s resources and options. Some strategies will reduce the overall cost more than others, and some strategies may involve nothing more than how a family should use their resources to pay for education. Our ultimate goal is to reduce the stress and anxiety of funding education for students and parents to have a successful college experience.
At Total Wealth Planning we help our clients every day answer these important and at times stressful questions. Who’s helping you?
Financial planning is complex and requires the guidance of a trusted and experienced advisor, such as a fee-only Certified Financial Planner™ (CFP®), who plans comprehensively, and with a complete understanding of your particular concerns and goals in life.
For more information about the financial planning strategies we utilize, please visit us at www.twpteam.com or contact directly Rob Lemmons, CPA, CFP® at 513-984-6696.
