The coronavirus pandemic has caused historic disruption in daily life. Individuals pursuing post-secondary degrees were significantly affected, as most universities, colleges, and trade schools transitioned to virtual learning early in the pandemic and many institutions plan to continue online instruction for the upcoming academic year.
This change could dramatically reduce your expected education expenses for the 2020-2021 school year, and you may have found yourself asking questions about what this means for your 529 education account. How can you creatively optimize these funds in this new education landscape?
A 529 is a tax-advantaged education savings account that allows money to be saved and invested for a beneficiary. The earnings grow on a tax-deferred basis, and funds can be withdrawn tax-free to cover the cost of specific qualifying education expenses. The most common qualified education expenses include tuition, room and board, and books. With the majority of students now learning from home, many of the typical expenses will be reduced for the remainder of 2020.
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Living at home may significantly reduce housing costs for many. For students living in their parents' home, 529 withdrawals can be applied to room and board up to the stated allowance provided by the college. For individuals renting off-campus living space, 529 funds can be used to cover the cost of rent.
Technology, such as computers, tablets, monitors, printers, internet service, and certain software programs are also qualifying expenses, as online learning has changed the computer from beneficial to essential.
It is important to confirm that the planned expense is a qualifying expense since making a withdrawal for a non-qualified expense from a 529 plan results in a penalty of ordinary income taxes plus 10 percent on the earnings. This is particularly important this year, as the CARES Act allows withdrawal from a 401(k) for coronavirus-related expenses without the early withdrawal penalty, but this is not the case for 529 plans.
Many institutions that canceled in-person instruction at the start of the pandemic have issued partial refunds for tuition, as well as room and board. This refund has created a dilemma for individuals who utilized their 529 for education expenses since regulations required the funds to be redeposited to the 529 plan by July 15, 2020, or they risk being taxed and penalized on the refund amount. For students returning to school in the fall (in-person or online), the refunds can be applied to these expenses.
If you find yourself in this situation, accumulating legitimate, qualified education expenses for the remainder of 2020 is particularly important. In 2019, Congress passed the SECURE Act, which expanded 529 qualified expenses to include student loan payments. The SECURE Act allows up to $10,000 in eligible student loans to be paid with 529 funds. While most student loan payments were automatically suspended until September 30, 2020, you will still have time to utilize your 529 to make loan payments before the end of 2020.
Not all students will be returning to class when schools reopen. If you or your child's plans change entirely, the beneficiary on the 529 account can be switched to a qualified relative (i.e., siblings) without a tax penalty.
Despite the many uncertainties caused by the pandemic, 529 accounts are still a great way to save for college. The disruption has created opportunities to utilize the 529 account to help your child succeed in this new learning environment. That is why it is critical to have a strategy in place to best utilize the account you've worked so hard to accumulate.
Sean Gould, CPA/PFS, CFP, is Senior Wealth Strategist at Waddell & Associates. He can be reached at firstname.lastname@example.org.