Have you received college tuition refunds or room and board reimbursement? Here’s what you should know about refunds or credits.
Question: My college refunded a portion of my tuition and room and board fees due to the changing situation brought on by COVID-19. What should I do now?
College life has changed for a lot of students this year. With cancellations and changes to in-person classes and on-campus housing, many colleges have provided students with refunds for a portion of their room and board charges. They’ve also offered refunds for tuition and related fees to compensate for the changing circumstances. Is this free money? Not really. Here’s what you should consider doing with college tuition refunds.
If you have a student loan and no distributions were taken from a Section 529 Plan
Do you have a federally funded student loan? If you’re in the repayment phase of your loan, you’re likely aware of the payment and interest deferrals that are active. Through September 30, 2020, the CARES Act sets the interest rate on federally funded loans to zero percent. It also suspends any payments that are due. The good news? Any payments made during this period will reduce your principal amount by 100 percent. This provides a benefit that will be felt far into the future. Your loan will be repaid faster, greatly reducing your interest costs and future debt. If you have a student loan, it’s a great idea to repay a portion of your loan with the refund you received.
Not all student loans are federally funded. You should contact your lender to determine if there are any deferral programs available on your loan. Many private student loan lenders are offering similar forbearance options.
If the funds came from a Section 529 Plan
Section 529 plans are a great vehicle to help pay for education. 529 plans allow invested funds to grow tax-free if the funds are used for qualified education expenses. Some states even offer deductions for contributions. The caveat to obtaining tax-free treatment is that the distributions must be used for qualified education expenses. If they aren’t, the earnings are subject to income tax at the beneficiary’s tax rate. The funds will also be subject to an additional tax penalty of 10 percent. Any state deductions may also be subject to recapture.
To avoid these consequences, you should return the refund received to your Section 529 plan within 60 days of the date of the refund. These amounts will not be considered additional contributions for the year. Instead, they will be considered a recontribution to your plan.
Here is a plan of action to consider:
- When you are issued a refund from the college, print out and store the date the refund was issued and the amount of the refund. These two items will be crucial proof in the event the IRS attempts to tax this as a taxable withdrawal.
- Contact the Section 529 sponsor for the proper method of recontributing the funds. You can only recontribute up to the amount of the refund. If you recontribute more than the refund, the excess will be considered a new contribution subject to the current contribution rules. For example: If you withdrew $20,000 from the Section 529 account to pay the spring semester room and board and tuition, but you only received $5,000 as a refund from the school, only $5,000 can be recontributed to your account.
- Follow the instructions provided by the sponsor of the account. Include a letter of instruction that details the following and send it with a check, not an electronic payment, so there is a complete paper trail of the transaction.
Include the following on the letter of instruction:
- Indicate that this is a 529 plan recontribution of a refund received from the college in 2020;
- State the amount of the refund that is being recontributed;
- Make clear that the payment is not a new contribution, but should be characterized in your account as a recontribution of a previous amount withdrawn from the account;
- Include the account number and the name of the student beneficiary. Also include the date and the amount of the previous qualified withdrawal from the account that this recontribution is fully or partially covering;
- State that the recontribution is being made within 60 days of receiving the refund from XXX College. Include the date the refund was issued and the amount of the refund. Even consider including a copy of the refund statement from the college that issued it.
Some plans may allow you to endorse the refund check the college issued to you, making it payable to the plan sponsor. This can be an added protection of proving you did not use the refund for nonqualified purposes.
Caution: Verify that the plan sponsor will allow you to do this before proceeding. If the sponsor will not accept it in this manner, you may find out after the 60 day window passes you by.
Keep a copy of everything you submit
The paper trail is your proof that you complied with the law and the timing. Keep a copy of everything you submit to the plan sponsor and consider sending it via U.S. Mail. Get it certified, and request a return receipt, so you have proof of complying within the designated window. Other delivery services may not necessarily qualify as proof of delivery in the event there is a question of the item being received or being received within the required time frame.
This procedure is available whether you are the beneficiary or the account owner. However, it is important that any refund received goes back to the proper account.
If your school did not offer a refund, but instead offered a credit toward future costs
A credit towards future costs instead of a refund may seem like a good alternative. However, a credit can come with drawbacks. Because you did not receive cash, you do not have the ability to recontribute the refund to the 529 plan. This means your distribution now becomes nonqualified, with unintended tax consequences. Also, these credits usually will reduce your financial need. The credit will be considered part of your estimated financial assistance. Thus, your need-based financial aid for next year may be negatively impacted.
While receiving college tuition refunds or credit and returns on fees is normally great, you should not consider it “free money.” In this case, it can wind up costing you money through taxes and penalties and reduction in future financial assistance. If you don’t wish to recontribute the funds to your 529 plan, it may be possible to look for substitute qualified education expenses. Did your classes move to online learning? Internet expenses, computer program expenses, or a new computer (if required) may be acceptable qualified expenses for which a portion of the refund may be used. Refer to IRS Public 970 Tax Benefits for Education for more information on qualified education expenses and recontributions to qualified tuition plans.