If you run into a situation where your child stops attending their college or university part way through a semester and as a result tuition and other college costs that were paid using your child’s 529 plan are returned to you, what options are available to you with regard to this unexpected refund of college payments?

The easiest option is to return the funds back into the 529 plan that the funds came from.  Or you can fund a different 529 plan as long as the 529 plan pertains to the same beneficiary (child).  There is a strict timeline involved with this option – the funds need to be recontributed back to the 529 plan within 60 days from the date the check was issued by the educational institution.  Missing this 60-day window will result in taxes plus a 10% penalty on the earnings portion of the 529 plan funds returned to you.  We also recommend contacting the 529 Plan’s customer service to determine other documentation that might be required by the 529 plan in recontributing the funds.

Additionally, there are a few other options when students are refunded tuition that was paid from 529 plan distributions:

  • First, you can use the returned funds to pay for other qualified college costs for this same child. However, the funds must be used in the same year and if not used for qualified educational expenses by year-end, then the earnings portion of the refund allocated to the 529 plan funds becomes a taxable event, plus the 10% penalty as noted above.  If risk and/or uncertainty exists on using the funds for this beneficiary elsewhere, then this option may not be the best option.
  • Another option would be to use these funds to pay down educational debt. However, there is a lifetime limit of $10,000 on the repayment of student debt using 529 plan distributions.  This lifetime limit is per borrower (child).
  • The final option would be to keep the money and pay the taxes on it. If keeping the funds and paying taxes, have the funds distributed in your child’s name.  The receiver of the refunded costs related to the 529 plan funds will be the one required to report the amount as income on their tax return.  Most likely, your child will be in a low tax bracket.  If the refund is sent to the account owner/parent, most likely the tax burden would be higher based upon the parents being in a higher tax bracket than the child.  And whether the college returns the funds to the parent or child, in this situation, the 10% penalty is not avoided.