What you should know about 529 plans and 0% interest for student loans

WASHINGTON » The COVID-19 pandemic has made financial planning for higher education even harder.

Parents and students are trying to figure out college costs for next fall — assuming schools even reopen like normal. There’s the question of what to do with money taken from a taxadvantaged 529 education savings plan. And should you still make payments on a student loan even if you don’t have to?

Here’s what you should know about 529 plans and student loans during the coronavirus crisis.

Q

Should I continue making student loan payments during the forbearance period?

A

The Coronavirus Aid, Relief, and Economic Security Act or Cares Act automatically suspended payments for most people with federal student loans until Sept. 30.

During this payment “pause,” interest on federal loans owned by the government is effectively reset to zero percent.

If you’ve lost your job or been furloughed, you may not have a choice. You have to take the payment break.

But you might want to consider continuing to make payments if you can afford to do so. Keep in mind that every penny of your payment goes straight to reducing your principal, which will save you money in the end.

However, if you qualify for the Public Service Loan Forgiveness (PSLF) Program, or you’re close to loan forgiveness for an income-based payment plan, you could use the payment break to cover other expenses or build your savings.

By the way, if you meet all the conditions under the PSLF program, you will receive credit toward loan forgiveness for any payments that are waived due to the Cares Act. It would be as if you made the payments.

Q

What is the possible tax ramification for college refunds of money taken from 529 plans?

A

Colleges that sent students home from campuses have been issuing refunds for tuition, fees and room and board. For some families, it’s a welcome injection of money.

But the refunds have created concern for people who paid college expenses with money withdrawn from a 529 college savings plans, which allows contributions to grow tax-free. If the funds are used for qualified educational expenses, earnings are generally not taxed.

However, if money from a 529 plan is not used for qualified education expenses, referred to as a “non-qualified” distribution,

the account holder has to pay income taxes on the earnings and an additional 10% penalty.

Typically, if you withdraw money from a 529 plan and need to put it back, you have 60 days from the date the money is refunded to return the funds without penalty, which only applies to the non-qualified distribution.

But these are not normal times. Because of the pandemic, the IRS has issued guidance that gives 529 plan account holders a wider window to return the refunded money, according to Roger Young, a senior financial planner at T. Rowe Price.

If the 60-day period ended on or after April 1, account holders have until the July 15 tax deadline to replace the money without incurring taxes or the 10% penalty.

“For a beneficiary continuing college in the fall, the family probably doesn’t have to worry about re-contributing,” Young said. “The fall qualified expenses will likely be much more than the refund they received.”

If your child is graduating and won’t need the money, another option is to put the funds back and then transfer it to a sibling or another eligible family member, Young said.

“The ability to contribute refunded qualified higher education expenses back into a 529 plan speaks to the flexibility of 529 plans and their usefulness as savings tools for parents and students managing through the challenges and uncertainties of these times,” said Vivian Tsai, senior director with TIAA’s Education Savings business. “If a student is graduating this spring and is considering future graduate school, then any refunds may still be redeposited into their 529 plan account to remain invested in perpetuity until that future scenario plays out.”

With more classes perhaps being taught online, you might use the money to upgrade your child’s computer, which is a qualified expense, Tsai said.

Q

Should I continue contributing to a 529 plan with all the market volatility recently?

A

Even if college campuses don’t reopen for in-person classes, you’ll still need money to pay for tuition and fees.

A 529 plan still remains attractive for the tax benefits, Tsai said. And the majority of 529 plans provide account owners with access to professionally managed investment portfolios and diverse investment choices, including principal-protected or moneymarket options.

“Generally speaking, the sooner that the money is needed, the more conservatively the funds should be invested,” Tsai said. “It can be risky to have excessive exposure to asset classes with higher expected volatility, like stock.”

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