A 529 college savings plan is a tax-advantaged tool to save for a child’s education. However, there are some circumstances where you may have leftover dollars. If that’s the case, you may wonder, “can you use your 529 plan to pay down student loans?”
Previously, student plans weren’t an acceptable use for 529 funds. But under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, that rule was changed, and now the federal government allows account holders to use their 529 plans to pay off up to $10,000 in student loan debt. However, the rules are strict, so you need to know the ins and outs before withdrawing.
What is a 529 plan?
There are two forms of 529 plans: prepaid tuition and college savings. College savings plans are the more commonly used of the two because they allow people to invest and potentially grow their contributions over time.
A 529 plan is an investment account tied to a specific beneficiary. You can invest in stocks, mutual funds, and other securities, and your contributions can grow tax-deferred. Withdrawals made for qualifying education expenses, including college tuition, are tax-free. Expenses that qualify for 529 plans include:
- Tuition
- Fees
- School-required equipment
- Room and board.
Withdrawals made for non-qualifying expenses are subject to income tax and penalties.
Can you use a 529 plan for student loans?
Previously, account holders couldn’t use their 529 plans to repay student loans without incurring income taxes and penalties. However, the SECURE Act of 2019 changed that. Under the new federal law, 529 account holders can withdraw up to $10,000 for student loan repayment.
Using a 529 plan to repay student loans is an unusual use for the account; they’re typically used to pay for college expenses upfront. But there are a few scenarios where it may be a good idea:
- One child doesn’t go to college: Let’s say you have two children. One decides to attend a pricey private school. His 529 plan doesn’t cover all of his expenses, so he takes out student loans for the remainder. Your other child decides against going to college. You can switch the account’s beneficiary to the student in college to pay off their student loans.
- The stock market drops: If the stock market performs poorly, the 529 account will be worth less. In some cases, it may make more sense to take out student loans rather than use the 529. You can withdraw money to repay the student loans when the market recovers.
- The student planned on loan forgiveness: Some borrowers take out student loans and hope the debt will be forgiven through Public Service Loan Forgiveness or other loan forgiveness programs. If their plans change and loan forgiveness isn’t an option, they can tap into their 529 plans to pay off student loans instead.
Qualifications to Use a 529 Plan to Pay Student Loans
To utilize the SECURE Act’s provision for 529 plans and student loan repayment, you must meet the following requirements:
- Amount: The amount of the distributions cannot exceed $10,000 of principal and interest for qualifying student loans.
- Eligible loans: Qualifying loans include both federal and private education loans. Other loans, such as personal loans, home equity loans, or loans from retirement plans, are not eligible.
- Beneficiary: The $10,000 limit is a lifetime maximum, not an annual one, and it applies to each beneficiary.
- Taxes: If you take advantage of this provision and withdraw money to repay student loans, you cannot claim the student loan interest tax deduction for the amount of debt you repaid.
Although the SECURE Act changed how the federal government handles 529 plans and student loan repayment, not all states have followed suit. Some states may prohibit the use of 529 plans for student loan repayment, so you may owe state income taxes and penalties if you withdraw money to repay your loans.
To find out how your state handles 529 withdrawals, check with your state education agency.
Pros of Using a 529 Plan to Pay Student Loans
- Tax-free withdrawals: When you use a 529 plan to pay for qualified education expenses or up to $10,000 in student loan debt, your withdrawals are tax-free.
- Flexible beneficiary requirements: If the account beneficiary gets a scholarship, attends a cheaper school, or decides against going to college, you can switch beneficiaries. You can switch it to a parent or sibling and use the 529 plan to repay the new beneficiary’s student loan debt.
- No age limit: Unlike some other college savings plans, 529 plans don’t have an age limit for beneficiaries. You can name a parent or even a grandparent as the plan beneficiary to repay their student loans.
Cons of Using a 529 Plan to Pay Student Loans
- Loss of tax deduction: When you withdraw money from a 529 to pay off student loan debt, you cannot claim the student loan interest tax deduction.
- Relatively small maximum: The SECURE Act’s provision set a lifetime cap of just $10,000 per beneficiary. That number is too low for most borrowers to pay off their debt completely.
- Not available to everyone: Depending on the state managing your 529 plan, you may not be eligible for the SECURE Act’s provision.
How to use 529 for student loans
If you decide to use some of your 529 funds to repay student loans, follow these steps:
- Check with the state issuing the 529: Check with the state behind your 529 plan to see if student loan repayment counts as an eligible qualifying education expense; otherwise, you may have to pay income taxes and penalties.
- Decide how much to withdraw: Under the SECURE Act, $10,000 is the lifetime maximum you can withdraw from a 529 plan for student loan repayment. However, you can take out less money. Sometimes, taking out only enough money to pay off your highest-interest debt may make sense.
- Contact the plan administrator: Once you know how much money you want to withdraw, contact the plan administrator to request a distribution.
- Make the payment: Depending on the state’s options, you may be able to pay the lender directly, or you may reimburse yourself via check or electronic debit.
Alternatives to 529 Plans for Student Loan Repayment
If you don’t have enough funds in a 529 account to pay off your student loans or live in a state that prohibits using 529 dollars for student loan repayment, there are other ways to manage your debt:
- Debt avalanche or debt snowball methods: The debt avalanche and debt snowball methods are debt repayment strategies that help you pay off your balances faster and save money.
- Consolidation: If you have federal loans, you can consolidate your student loans with a Direct Consolidation Loan. It will simplify your payments, and you can extend your repayment term to get a lower monthly payment.
- Alternative repayment plans: If you have federal student loans, you can enroll in an income-driven repayment plan to reduce your monthly payment.
- Employer repayment programs: Some employers will match your monthly student loan payments up to an annual and lifetime maximum. Taking advantage of employer repayment assistance programs will help you save money.
- Student loan refinancing: You can refinance both federal and private student loans, and if you have good credit, you could qualify for lower interest rates and different repayment terms. Some borrowers can save a substantial amount of money and become debt-free faster through student loan refinancing.
Speak to a Loan Advisor About Refinancing Your Student Loans
Although the SECURE Act made it possible to pay off a portion of your student loan debt with your 529 plan, it may not be enough to eliminate all of your loans. Refinancing your debt may be a smart strategy if you still have a balance.
You can get personalized guidance throughout the student loan refinancing process from a financial advisor. The benefits of talking to an ELFI loan advisor include:
- One-on-one assistance
- Advice on which loan term to choose
- Information on what interest rates to expect
- Support through every stage of the application process
Set up an appointment with an ELFI loan advisor today!