How to Avoid Penalties if You Received a Refund from Your Student’s College

As a result of the COVID-19 pandemic, schools everywhere needed to adapt to how they were able to provide an education to their students.  During the spring of 2020, many colleges had no alternative but to close their campuses and send dorming students home.  As the fall semester began it was still necessary to implement coronavirus precautions and colleges were again forced to make adjustments.  Whether it meant switching to a virtual learning format or opening campuses with limited amenities and extracurriculars available, the college landscape looked and felt different than it had only the year before.  Due to these changes, some have schools offered refunds to students who had already paid for various unused services such as housing, dining, or parking fees.

How will I know if my student will be getting a refund?

While not every school is offering refunds, and not every student is eligible to receive one, it’s important to note that it might be your student, and not the parent or person paying the bills, who is made aware of the refund.  Some schools may choose to credit a refund directly into a student account or provide students with a check made payable to the student, so it can be helpful to speak with your child to learn if they have already received one.

What should I do if my student does receive a refund?

If you previously distributed those funds from a 529 College Savings Plan, you may want to consider recontributing any refund of qualified expenses from an eligible educational institution back into the account for the same beneficiary, as state and federal taxes plus a 10% federal penalty tax may apply if you choose to keep the refund. Refunds must be redeposited within 60 days of the date the funds were withdrawn.  Income tax is imposed only on the earnings portion of the 529 plan distribution not used to pay qualified education expenses.  If you are beyond the 60-days or if you would prefer not to re-deposit the funds, you could also spend those funds on other qualified education expenses such as computer hardware and software.

Should you still recontribute your refund check to your 529 account if your beneficiary is graduating soon?

529 plans do not expire, and the account’s beneficiary can be changed.  By recontributing the funds, you will avoid taxes and penalties, and can allow the funds to continue compounding for the benefit of another family member’s education.

When would I be taxed on a 529 plan distribution?

529 College Savings Plan distributions are not taxed when used for qualified education expenses in the same calendar year.  For example, if 2020 qualified college costs are $40,000 and you distribute $40,000 in 2020 from a 529 plan to pay those expenses, you will report those amounts on your 2020 tax return and no taxes will be due on the earnings from your 529 plan distribution.  If college costs decrease to $35,000 and you receive a refund of $5,000, then you can re-contribute the $5,000 or become subject to the tax implications of that excess distribution.  If however, qualified education costs are $40,000 but you only distributed $30,000 from the 529 plan and the college refunded $5,000, you would not need to return the refund to the 529 plan because 100% of your 529 plan distribution was used to pay for qualified education expenses.

As we all continue to adapt to these challenging times, remaining proactive in learning about changes that can affect us is one of the best ways to continue making smart financial decisions.  If you have any questions about the best way to manage a refund from your child’s college, please contact us.