Here’s what you should know about 529 plans and student loans during the coronavirus crisis.
Q: What are the tax ramifications of getting a refund for college tuition paid through a 529 savings plan?
A: Colleges that sent students home from campuses have been issuing refunds for tuition fees and room and board. For some families, it’s a welcome injection of money.
But the refunds have created concern for people who paid for college expenses with money withdrawn from a 529 college savings plan.
A 529 plan allows contributions to grow tax-free. If the funds are used for qualified educational expenses — required textbooks, computers, related equipment, software and Internet access as well as tuition, room and board — earnings are not taxed.
However, if money from a 529 plan is used for something other than qualified education expenses, what the IRS refers to as a “non-qualified” distribution, the account holder has to pay income taxes on the earnings and an additional 10 percent penalty.
Typically, if you withdraw money from a 529 plan and need to put it back, you have 60 days from the date of the refund to return the funds without incurring a penalty.
But these are not normal times. Because of the pandemic, the IRS has issued guidance that gives 529 plan account holders a longer window to return the refunded money, according to Roger Young, a senior financial planner at T. Rowe Price.
If the 60-day period ended on or after April 1, account holders have until the July 15 tax deadline to replace the money without incurring taxes or the 10 percent penalty.
The extra time means some families won’t have to worry about putting the money back into the 529 because they will soon be paying it right back out again when their kid returns to college in the fall.
“For a beneficiary continuing college in the fall, the family probably doesn't have to worry about re-contributing,” Young said. “The fall qualified expenses will likely be much more than the refund they received.”
If your child is graduating and won’t need the money, another option is to put the funds back into the 529 and transfer it to a sibling or another eligible family member, Young said.
“If a student is graduating this spring and is considering future graduate school, then any refunds may still be redeposited into their 529 plan account to remain invested in perpetuity until that future scenario plays out," said Vivian Tsai, senior director with TIAA’s Education Savings business.
With more classes perhaps being taught online, you might use the money to upgrade your child’s computer, Tsai said.
Q: With all the recent market volatility, should I continue contributing to a 529 plan?
A: Even if college campuses don’t reopen for in-person classes, you’ll need money to pay for tuition and fees.
A 529 plan still remains attractive for the tax benefits, Tsai said. The majority of 529 plans provide account owners with access to professionally managed investment portfolios and diverse investment choices, including principal-protected or money market options.
“Generally speaking, the sooner that the money is needed, the more conservatively the funds should be invested,” Tsai said. “It can be risky to have excessive exposure to asset classes with higher expected volatility, like stock.”
Q: Should I continue making student loan payments?
A: The Coronavirus Aid, Relief, and Economic Security Act or Cares Act automatically suspended payments for most people with federal student loans until Sept. 30.
During this payment “pause,” interest on federal loans owned by the government is effectively reset to zero percent.
If you’ve lost your job or been furloughed, you may not have a choice. You have to take the payment break.
But you might want to consider continuing to make payments if you can afford it. Keep in mind that every penny of your payment goes straight to reducing your principal, which will save you money in the end.
However, if you qualify for the Public Service Loan Forgiveness (PSLF) Program, or you’re close to loan forgiveness for an income-based payment plan, you could use the payment break to cover other expenses, or build your savings.
By the way, if you meet all the conditions under the PSLF program, you will receive credit toward loan forgiveness for any payments that are waived due to the Cares Act. It would be as if you made the payments.