Navigate a Possible COVID-19 Related 529 Education Plan Trap

Covid-19 has had a major impact on almost everyone’s life. Even daily tasks have been affected. I can’t tell you how many times I’ve left the house only to have to run back into the house to grab my mask. Fortunately, if I do forget my mask, it’s only a minor inconvenience to drive home and get it before I continue my errands. At this point, I have an extra mask in my car just in case anyway. For those with 529 plans, the way colleges are handling refunds or credits for the Spring 2020 semester could result in more than just an inconvenience and have direct financial impacts.

School was cut short this Spring for every student. Most colleges are offering refunds to reflect the change in how classes were held. The way these credits are showing on the statement of student accounts has been unusual in some cases. We are noticing that for some universities, checks for the discount are being issued, but the credit is being shown as a reduction in amounts billed during 2019, not 2020.

Why is this important? For those with 529 plans, you are aware that a distribution in excess of qualified expenses can result in a 10% tax penalty on the excess funds and turn some of what were qualified earnings into taxable ones. Many will use the statement of student account or an invoice to determine how much to withdraw. If your university is showing the Spring 2020 credit on the 2019 statement of student account, it may be overlooked when it comes time to plan 529 plan distributions, and it could become quite easy to over withdraw from your 529 plan in 2020 by the credited amount. Don’t forget you received this credit! It’s important to factor this amount into your 2020 529 plan distribution to avoid being taxed on excess distributions. Become familiar with how your university is handling this, and plan accordingly.

On a separate note, it’s important to take advantage of the American Opportunity Credit, if eligible, on your tax return. If you are fully eligible, paying $4,000 out of pocket before utilizing your 529 plan can result in a $2,500 tax credit. This is free money back in your pocket! Don’t make the mistake of missing this credit by paying for college fully with your 529 plan funds. While paying out of pocket will have a  negative cash flow impact, it is better to spend $4,000 at an ultimate cost of $1,500 than pay with 529 plan funds entirely and forgo this opportunity. Be sure to speak with a CPA like an advisor at Campbell Financial Services to see how to best handle your tax credits and college education payments.