Excess 529 Funds?

So, you were a #ResponsibleAdult and you planned for your child’s future with a 529 plan. They were attending school and you withdrew funds to pay for their tuition and room and board. Then, the universe threw you a curve ball, causing your child’s university to put all classes online and/or require students to stay at home (like in a pandemic). Now you’re stuck with excess 529 funds that you aren’t using for qualified education expenses. What do you do?

You have a few options.

1. Put the money back in the 529 Plan

You can return withdrawals to a 529 plan if it has been less than 60 days since you took the distribution. That way, there are no tax consequences. You are only allowed to do this once in a 12-month period.

2. Roll the money to a different 529 Plan

If you think you will not use the money for that same child, you can always roll the cash to a different child’s 529 account. You can do this anytime – not just when you have excess 529 funds withdrawn. Maybe your child decides to change plans and go to a less expensive school closer to home. They won’t need all of the money you’ve saved. You can put the money back into a different child’s (or grandchild’s) 529 plan, as long as it is within the 60-day period. You can also put the money back into a different 529 account for the same child. For example, let’s say Grandma and Grandpa (G&G) started a 529 plan for your kids. You also started one for you to save. You took money out of the G&G 529 plan for college this fall, and then, due to COVID-19, circumstances changed, and you didn’t need all of the money. It is more convenient for you to put the money back in the 529 plan you control, rather than try to go through G&G and the 529 plan company to coordinate. Go ahead and put the money back in the 529 plan you have.

3. Pre-pay qualified education expenses

If the school allows prepayment, you can use the excess 529 funds to pre-pay tuition or other qualified expenses before the end of the year. 529 Plan distributions must be made during the same tax year that expenses are incurred, so if you took the distribution in 2021, you will want to pre-pay 2021 expenses before 12/31/21 so that you don’t cross tax years. Typically, you can’t do this with things like room and board.

4) Take the hit

I don’t recommend this option, but if you have no other options, then your last available option is to leave the funds out of the 529 plan and pay ordinary income tax plus a 10% penalty on the earnings portion of the distribution. This is a key distinction: If you took a $5,000 distribution, that was made up of your $4,000 contribution to the account and its growth of $1,000, you only must pay the tax and penalty on the $1,000. Likewise, if you have a loss on the investments in the 529 plan, then there may not be earnings and thus no taxes to pay.

Excess 529 withdrawals don’t happen very often but may indeed happen.

Any opinions are those of Jill Carr and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.

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