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The answer is yes! You can use 529 plans to pay off student loans.
529 plans are a great way to save for college, because they offer tax breaks and other benefits. But you might be wondering if it’s possible to use your 529 plan to help pay off your student loans.
The short answer is YES! Here’s how:
If you have a 529 plan, you can withdraw up to $10,000 per year from the account without penalty—and any withdrawals after that will only be subject to a 10% penalty (most states require this). That means that if you have more than $10,000 in your account, you can make a withdrawal and use it for whatever purpose you want—including paying off student loans. In some cases, depending on how much money you’ve saved up in your account and what state you’re from, it may even be possible for you to make multiple withdrawals per year without getting hit with any penalties at all! You can also choose whether or not the funds are used for educational purposes or for personal expenses like rent or groceries.
So now that we’ve answered the question of whether or not it’s possible to use 529 plans for other purposes than education-related expenses… let’s talk about how!
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Can a 529 Plan Be Applied to a Student Loan?
Student loan debt has become one of the largest classes of consumer debt in the country. In fact, it affects as many as 43 million Americans.1 According to a report from Forbes, student loan debt reached almost $1.5 trillion in early 2019, with the average borrower from the class of 2018 owing as much as $29,200 in student debt.23
Finding the money to pay down student loans—let alone pay for school—is a struggle for many new grads who are just starting out in the workforce. Loan forgiveness programs can offer some relief, but only for borrowers who work in selected fields.4 But there’s a plan in place that not only helps people save for tuition and other expenses tax-free, but it also helps them pay a portion of their student loans—or those of their beneficiaries—without facing any penalties.5
529 plans are tax-advantaged savings plans originally designed to cover the costs of post-secondary education of the plan holder’s beneficiary.
The Tax Cuts and Jobs Act (TCJA), signed in 2017, expanded coverage to include qualified tuition expenses for K-12 education.
Under the SECURE Act of 2019, plan holders can use 529 plans to pay for tuition and qualified expenses of apprenticeship programs and can withdraw a lifetime maximum of $10,000 to pay down student loan debt.
The Basics of the 529 Plan
Created in the 1990s as a way to help people pay for the costs associated with post-secondary education, 529 plans are tax-advantaged savings plans.67 The plans let people grow savings for a beneficiary—a child, grandchild, or spouse. The plan also allows people to save for themselves.8
There are two types of 529 plans—prepaid tuition plans and savings plans. Prepaid tuition plans give plan holders the ability to prepay tuition and other fees for the beneficiary, provided it is at a specified institution. Savings plans, on the other hand, resemble individual retirement accounts (IRAs) in that they are tax-advantaged plans.
Plan rules were laid out in Section 529 of the Internal Revenue Code (IRC). For instance, withdrawals from 529 plans were 100% free of federal taxes if they were used to cover qualified education expenses such as tuition and fees, or room and board.8
In January 2017, House members Lynn Jenkins (R-Kan.) and Ron Kind (D-Wis.) introduced H.R. 529, also dubbed the 529 and ABLE Account Improvement Act of 2017.10 The bill was primarily designed to encourage employers to contribute funds to 529 plans on behalf of employees via a tax incentive. Up to $100 in employer contributions to these accounts were excluded from taxes. Small businesses that made 529 plan contributions also got a tax credit to help with the cost of setting up payroll deductions for these accounts.11
The legislation also benefitted savers by removing penalties for using 529 funds to pay off student loans. Taxpayers who used 529 plan money for anything other than qualified education expenses were subject to a 10% federal tax penalty. Any distribution of earnings was considered taxable income, which could drive the saver’s tax liability even higher.119
The bill was considered a boon for families with leftover 529 plan money who want to avoid a tax penalty for making nonqualified distributions. The Internal Revenue Service (IRS) did allow accounts to be transferred from one beneficiary to another in the past, but if there are no other students in a family that can use the money, the account owner must either leave the fund unused or accept the tax liability.12
Changes to 529 Plans
There have been several changes to the way plan holders can use 529 plans as of 2017 with the Tax Cuts and Jobs Act (TCJA), as well as with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019.1314 Both laws were signed by President Donald Trump.1516
The TCJA changed the way 529 plans could be used, increasing some of their benefits. The primary change expanded coverage beyond post-secondary education to include a maximum of $10,000 in annual tuition expenses per student for K to 12 education at a public, private, or religious school. Other expenses do not qualify, and distributions made to cover any additional educational costs would be considered as gross income.
Additional changes were made to the plans after the U.S. House of Representatives passed the SECURE Act, which was signed on Dec. 20, 2019. Under Section 302 of the act, plan holders can now:
Use their 529 accounts to cover expenses related to any registered apprenticeship program attended by the beneficiary. This includes any additional costs such as fees, equipment, books, and other supplies.
Withdraw up to $10,000 from their plan to pay down qualified student loans penalty-free—with conditions. The first is that the $10,000 maximum is a lifetime limit for a beneficiary and each sibling. This means a family with two children can take out a maximum of $20,000 to pay down their student loans. Secondly, plan holders cannot claim any student loan interest deductions paid with this money.
The maximum lifetime limit a plan holder can withdraw from a 529 plan to pay down a beneficiary’s qualified student loan.
Can You Use a 529 Plan to Pay Student Loans?
Student loan debt remains one of the biggest kinds of consumer debt in the country. Although people with education debt have been limited to exploring existing avenues for managing their loans, there is a little relief. Since the passing of the SECURE Act, 529 plan holders are able to withdraw up to $10,000 tax-free to put toward their own student loan debt, or that of their children, grandchildren, or spouses.13 As with any other financial product, it’s a good idea to check with your plan administrator for full details on how this works.Compete Risk Free with $100,000 in Virtual CashPut your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you’re ready to enter the real market, you’ve had the practice you need.
New Law Expands Uses for 529 College Savings Accounts
Under the Secure Act, approved in December, up to $10,000 can be used to repay student loans. The law also allows 529 funds to be used for apprenticeships.
Tax-favored savings accounts known as 529 plans can help families save and invest to pay for college. But until now, the funds could not be used to repay student debt.
That changed as part of the Secure Act, a law attached to broader federal spending legislation enacted in December. The law was aimed mainly at adjusting the nation’s retirement system, but it also expanded allowable uses for 529 funds.
Under the new rules, up to $10,000 from a 529 account can be used to repay the beneficiary’s student loans. Plus, up to another $10,000 each can be used to repay student loans held by the beneficiary’s siblings. (If, say, a student had two siblings with student loans, another $20,000 total could be withdrawn, without penalty, to pay their debt.)
The new law also allows 529 funds to be used to pay for apprenticeships, which typically combine on-the-job training with classroom instruction, often at a community college. To qualify, the apprenticeship must be registered with the federal Labor Department.
The update is the latest expansion of permissible uses for the state-sponsored college savings plans. As of 2018, up to $10,000 a year per student can be used to pay for pre-college school tuition from kindergarten onward.
Money is contributed after taxes to 529 accounts, grows tax deferred and is withdrawn tax free when used for eligible expenses. (There is no federal tax deduction for 529 contributions, but some states offer tax breaks.) Earnings withdrawn for ineligible costs are subject to income tax, plus a penalty.
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Before the recent spate of changes, 529 savings plans were limited to paying for costs like tuition, fees, housing, meal plans, books and supplies.
“We’re really excited about giving families more options for how they can spend their 529 funds,” said Michael Frerichs, the chairman of the College Savings Plans Network, a group that promotes the state-sponsored plans.
The inclusion of apprenticeship costs, in particular, may relieve some families’ concerns that opening a 529 fund may be a disadvantage if their child decides not to attend college, Mr. Frerichs said.
The new option for loan payments may seem odd because the main goal for saving in a 529 account is to avoid borrowing for college in the first place. And 529 rules allow an account’s beneficiary to be changed to another family member at any time. So extra cash can easily be reallocated to another student to help pay for college expenses.
But despite the best-laid plans, families — especially those with multiple children attending college — may find themselves with both “leftover” 529 funds and student loans, said Mark Kantrowitz, publisher of Savingforcollege.com. He recently discussed strategies for using 529 funds to pay student debt.
The new loan payment option can help in multiple situations — some of which may seem complex but are relatively common, Mr. Kantrowitz said. Say a family has several children, each with a separate 529 account. If a younger sibling attends a less expensive college and does not need the full balance in the account, the family could use the money to help pay down the student debt of the older sibling.
Students could also end up with “excess” 529 money if they graduated from college in three years instead of four, perhaps by taking summer courses or earning advanced-placement credit.
Students may also have to borrow unexpectedly, say, if generous grandparents mistakenly run afoul of federal student aid rules, Mr. Kantrowitz said. Money saved in a grandparent-owned 529 account does not affect a student’s financial aid eligibility while sitting in the account. But once withdrawn, the “distribution” counts as student income and can reduce the student’s eligibility for need-based aid by as much as half of the withdrawal. (Grandparents often own the accounts in their own names so they can meet the requirements for income tax deductions offered by some states for 529 contributions.)
Student Loans: Key Things to Know
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Corinthian Colleges. In its largest student loan forgiveness action ever, the Education Department said that it would wipe out $5.8 billion owed by 560,000 students who attended Corinthian Colleges, one of the nation’s biggest for-profit college chains before it collapsed in 2015.
New sources of aid. The Education Department will use one-time waivers and adjustments to retroactively credit millions of borrowers with additional payments toward loan forgiveness. The move will help people seeking to have their loans eliminated under the Public Service Loan Forgiveness program and through the use of income-driven repayment plans.
Payments delayed again. President Biden pushed the restart date for federal student loan payments to Sept. 1, extending a pause put in place at the start of the pandemic. Millions of borrowers who have defaulted on their federal student loans will also get a fresh start and have their loans restored to good standing.
The cost of private loans. As the Fed changes its benchmark rate, private student loan borrowers should expect to pay more, as both fixed and variable rate loans are linked to benchmarks that track the federal funds rate.
One way to avoid that happening is to wait until January of a grandchild’s sophomore year to withdraw funds, Mr. Kantrowitz said. Because the federal aid application uses income from the prior two years, waiting will mean that no subsequent year’s financial aid eligibility will be affected (assuming the student graduates in four years). The student may have to borrow for the first three semesters. But later, under the new rule, $10,000 from the grandparents’ 529 fund can be used to help repay the debt.
“The Secure Act,” Mr. Kantrowitz said, “provides families with greater flexibility in spending 529 plan money.”
The average student loan burden for college graduates with debt is about $30,000. So $10,000 from a 529 account by itself is not going to solve the student loan problem, said Carrie Warick, director of policy and advocacy for the National College Access Network, a nonprofit group that advocates on behalf of low-income students. “If you have significantly greater than $10,000 in loans,” she said, “it’s not a game-changer.”
Here are some questions and answers about the new 529 rules:
Can I use 529 money to repay private student loans, as well as federal loans?
The provision applies to federal and most private student loans.
Can I use 529 funds to pay an education loan I took out for my child?
The Secure Act’s provisions apply to student loans held by the 529 account’s beneficiary or the beneficiary’s siblings. But there is a workaround, Mr. Kantrowitz said. For example, a parent, as the owner of a 529 account with a child named as the beneficiary, could make a change and designate himself or herself as its beneficiary and take a $10,000 distribution to repay federal or private parent loans.
Depending on how much money was left in the account, the family could first use $10,000 to repay a child’s loans and another $10,000 for a sibling’s loans, before making the beneficiary change and taking a distribution to repay the parent loan, he said.
When do the new 529 rules take effect?
The new 529 rules are retroactive to the beginning of 2019. But account holders may want to be cautious and check with their own 529 plan before withdrawing funds. The new rules are in effect for federal tax purposes, but it’s possible that some state 529 programs will not follow along and recognize student loan payments or apprenticeship costs as eligible expenses. (That happened with the earlier change that allowed 529 funds to be used to pay for pre-college education costs.) Account holders in states that do not go along with the new federal rules may be subject to state income taxes and penalties, or possibly a repayment of state tax breaks. The various 529 plans are evaluating the new law, Mr. Frerichs said, and it could be weeks or months before the issue is settled in each state.