2020 – “Gap Years” and 529 Plans

Gap years have always been an option considered by students leaving high school – and for a lot of reasons.  2020 marks a year when the list of reasons may be growing substantially.  A sudden change in the number of high school graduates who are reluctant to jump into college right away is creating uncertainty for the Higher Ed industry – and at a narrower level, for the families who have diligently planned financially and logistically for the college years.  Fortunately, flexibility in 529 plans has increased with the passage of three major pieces of legislation.

2020’s High School graduates have experienced a very different ending to their primary education than anyone who came before them.  Not having attended school in person for the final months of their high school career, not having attended a traditional graduation ceremony and being socially distant from their peers has certainly put them in a different mindset about how plans can go askew.

It’s not terribly surprising that, as a result, the class of 2020 is taking a more studied look at their options going forward.  The result of this is that one in six recent high school graduates is either planning definitely or highly likely to take a gap year prior to returning to school.[1]  This is way higher than the prior years’ 2-3% of otherwise college-bound seniors deciding to take a break.

Reasons for taking a gap year (or for simply deferring college indefinitely) include:

• Safety concerns and not wanting to be in an environment where coronavirus breakouts are a possibility;
• Lack of money because the student or family has had income losses due to the pandemic;
• A hesitancy to return to virtual learning and a desire to wait until in-person learning can resume;
• Wanting to re-assess priorities and plans in light of life-changing circumstances.

Historically, the gap year has probably been the creation of the student, and something they need to sell their parents on.  This year, I’m hearing the idea being floated by parents FIRST – and the reasons range from safety concerns to simply not wanting to pay the higher levels of tuition when so much of the on-campus experience that justifies these expenses will be missing from the equation.

CHANGING PLANS

Even for those who DO plan on attending college in the fall, many are planning on lightening the financial (if not academic) load.   As one parent I spoke to put it: “Why do I want to pay out-of-state tuition for this state school when my son can get the same course work from an in-state college…either way, he’s doing his next semester in my dining room!”

IMPACT ON 529 DISTRIBUTION STRATEGIES

For families who have carefully planned out the financing of college through the use of 529 plans, these changes in plans may cause a few concerns:

• What if I don’t use some of the money that I’ve put aside in my child’s 529 plan because of changes in their college path?
• What about money I’ve already taken out to pay for tuition we’re not going to be using?
• What kind of time limits am I up against?

Fortunately, there is a good amount of flexibility built into 529 plans, so a delay or change in the planning around educational pursuits rarely causes heartaches.  Caution is warranted, though… While the true benefit of 529 plans lies in the fact that gains are not taxed when used for qualifying higher education expenses, distributions that aren’t used for these expenses are taxable and subject to a 10% penalty tax.

BASIC 529 PROVISIONS CREATE FLEXIBILITY

In cases of a student delaying their studies, there really is not a worry from the standpoint of the 529 plan.  There is no ‘ticking clock’ that requires payments be made for a beneficiary’s education expenses prior to a particular date.  If a 529 beneficiary decides to take a really long gap and not start her education until she is 90 years old, she’ll be able to use the 529 plan assets tax-free (as long as the rules haven’t changed by then!)

Additionally, the ability to change 529 plan beneficiaries affords additional flexibility, particularly in the case of a beneficiary deciding not to attend college at all or deciding to attend a much less expensive school than planned. At any time, the beneficiary of a 529 plan can be changed to a family member… and the definition of ‘family member’ is quite liberal.  It includes:

• Natural or legally adopted children
• Parents or ancestors of parents
• Siblings or stepsiblings
• Stepchildren
• Stepparents
• Nieces or nephews
• Aunts or uncles
• The spouse of any of the individuals listed above
• The spouse of the beneficiary
• First cousins

Clearly, families with multiple children have plenty of opportunities to shuffle assets around to make sure they’re all used for qualifying expenses, thus escaping taxation.   A beneficiary could conceivably wait until they themselves have children, and at that point change the beneficiary to their own child, creating an opportunity for multi-generational education planning!

RECENT LAWS ADD MORE FLEXIBILITY

The Tax Cuts and Jobs Act of 2017, which went into effect in 2018, provided for distributions for grade school and high school tuitions to be considered Qualified Higher Education Expenses, up to $10,000 per year.  Families who want to use up unused 529 plan assets for a college aged beneficiary can conceivably use them toward his younger siblings pre-secondary education.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in December 2019, as its name implies, was primarily focused on retirement plans.  Still, 529 plans were also impacted by this piece of legislation, primarily in two ways:

• It allows for a $10,000 of distributions for any beneficiary to pay down student loan debt, and
• It created the opportunity for expenses related to certain non-collegiate apprenticeship programs to be approved as qualifying expenses.

Since 529 assets can be used to pay down student debt, this provides even more flexibility for someone looking to ensure their plan is used for qualifying expenses, even if their child decides to suspend college indefinitely.  Importantly, the $10,000 is a lifetime (not annual) limit.  But given the ability to change beneficiaries, a family with three children and two parents, all of whom have student loan debt, could take up to $50,000 from one child’s 529 plan by allocating money to the 5 family members as beneficiaries.

Further, if a student decides college isn’t for them after all, the ability to pay expenses on an apprenticeship program can be an attractive way for them to get into a situation where they can ‘earn while they learn.’

Finally, the Coronavirus Aid, Relief and Economic Security (CARES) Act that was signed into law in March helps to deal with situations where tuition was prepaid and because of the pandemic the student does not attend school.  The Act provides for the return of the tuition and other expenses, and if they were paid for out of a 529 plan the plan owner has up to 60 days to return the assets to the plan without them being treated as a non-qualified distribution.

For the majority of students, the COVID-19 pandemic will alter the way they acquire some of their education but won’t substantially change their trajectory in completing it.  For those, however, who do decide that a break or a change in path is warranted, one thing they shouldn’t need to worry about is losing tax benefits on the assets they’ve saved to get through!

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[1] Looking Ahead to the Fall of 2020: How COVID-19 Continues to Influence the Choice of College-Going Students, Art and Science Group LLC website April 2020