How to Avoid Tax Penalties on Your 529 Refund

Did you or your child receive a refund from college?  If so, that refund could be subject to taxation and a 10% penalty.

The IRS could consider this refund as no longer being used for Qualifying Education Expenses.  This refund would then be recharacterized as a taxable distribution. In order to avoid this, consider recontributing the refund back into the 529 plan.  This needs to be completed within 60 days of the refund, so time is of the essence.  Be sure to document the refund.  Make a copy of the refund statement and check. We have created step-by-step instructions to help you through this process.

Follow these steps:

1. The first step to get the money back into the 529 Plan is to contact the plan provider and find out what their requirements are to recontribute funds back into the account. Each state and 529 Plan is different, so be sure to contact yours first.
2. Draft a letter of instruction to the 529 plan provider. This letter should include:
   • The account number and the name of the beneficiary
   • The amount you want to recontribute
   • A note that you want the payment to be characterized as a recontribution of a previously qualified withdrawal
   • Include the name of the institution and the date the refund was issued
   • Add the statement, “this recontribution is being made within 60 days of receiving the refund”
   • State the date and amount of the originally qualified withdrawal from this account and if the recontribution is covering a full or partial withdrawal
   • Include a copy of the refund statement that you received
3. Keep records of the date and the amount of the refund and remember you can only recontribute the amount of the refund
4. Send the check with the letter of instruction. This check should be sent by the actual account owner.  Also, yes, it should be a check and not an electronic transfer from your bank account.  By sending a check with the memo line stating “529 plan recontribution of 2020 refund” you will have a paper trail if needed.
5. Lastly, be sure to make a copy of everything you are sending for your records. You need to be sure that you meet the 60-day window, so you may want to send it certified mail or registered mail.  Also, be sure to follow up to make sure it was recontributed properly.

Failure to get these funds recontributed could result in taxes and penalties. If you have questions, you should consult your financial advisor.