529 College Savings Plans - Refunds, Rollovers and Reimbursements

By Russell W. Hall, CFP®

As colleges and students struggle to adapt to a changing environment, this year has brought up a number of questions about 529 college savings accounts. For a refresher on the basics of these accounts, see our articles on 529 qualified expenses and withdrawals.

Refunds

We don’t ever remember this being much of an issue before…because colleges are rarely looking to give money back! But with the shift to online learning and closed dorms and cafeterias, many schools have issued some kind of refunds. If the money to pay the original bills came from a 529 account, the refund amount is reclassified as a non-qualified distribution and is technically subject to taxes and penalties. That’s because withdrawals that aren’t used for qualified college expenses are subject to federal taxes and a 10% penalty on the earnings. 

The solution is to get the refund money back into the 529 account within 60 days of receiving it. This can be done by sending a letter with a personal check to the 529 custodian or by transferring the funds electronically (if that option is available). As long as the money gets back into the account, you can avoid the taxes and penalties.

In some cases, we have heard of colleges sending the refunds back to the 529 account directly. Other schools offered to just credit the student’s account, with the refund amount to be held and used to pay future bills. Both of these options avoid the non-qualified distribution problem.

Rollovers

For families with more than one child headed to college and multiple 529 accounts, it can sometimes be a bit of a puzzle to figure out how to get funds where they are needed most. There might be a balance left in one account – maybe a student who went to a community college or received scholarships - while another child needs additional funding.

The good news is that the owner of the 529 account (usually the parent or grandparent) can change the beneficiary, or transfer money from one 529 to another without tax or penalty. We’ve done this several times, and it’s often as simple as a letter of instruction to the 529 custodian. You can transfer any amount up to the full balance of the account.

While the rollover process is straightforward, there are a few things to watch out for.  You can only complete one rollover per receiving beneficiary in a 12-month period, so you can’t move funds around often. The funds must be rolled over within 60 days - usually not an issue if both 529 accounts are at the same custodian, but that’s not always the case. You also want to make sure that the cost basis and earnings numbers are updated in the new account, so that the recordkeeping is accurate. Most of the time this information will be automatically brought over.

Reimbursements

We’ve covered reimbursements extensively before, but there have been some recent changes.  The most important one is that you can now use funds from a 529 account to pay off up to $10,000 of student loans, where previously student loans were not a qualified expense.  That $10,000 is a lifetime limit per student.

Another interesting change is that apprenticeships are now considered to be qualified expenses, as long as the program is registered and certified under the National Apprenticeship Act (search for eligible programs here. This can be valuable for students who are taking a different path of study and don’t plan to go to a traditional college.

It’s important to note that individual states don’t have to conform to federal regulations for 529 accounts, and many do not.  For instance, distributions for primary K-12 education are tax and penalty free at the federal level, but some states don’t abide by that rule. This could also be the case for paying off student loans, but not every state has issued guidance yet so you should double check before doing anything. Unfortunately for our California clients, both student loans and apprenticeship expenses (along with primary education payments) are not eligible and are considered early distributions, subject to taxes on the earnings and a 2.5% penalty.

One final note: We are experts in financial planning, but sometimes the issues involving 529 accounts can fall into the realm of tax planning, and for any tax related questions you should consult with a tax professional.

If you have additional questions, schedule a 15-minute discovery call with a fee-only financial advisor.