Can you use a 529 plan to pay off student loans?
Some students graduate with leftover money in their 529 college savings plan and would like to use this money to pay off all or part of their student loan debt. Thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act signed by President Trump, now you can pay student loans with money from a 529 college savings plan.
The goal of the SECURE Act is to improve savings habits in the United States. This legislation expands the benefits of 529 college savings plans, including adding student loan repayment and cost of apprenticeship programs as qualified expenses. The new law applies to 529 plan distributions made after December 31, 2018.
How Paying Student Loans with a 529 Plan Works
The SECURE Act allows families to take tax-free 529 plan distributions for student loan repayment. Principal and interest payments toward a qualified education loan, which includes federal and private student loans, will be considered qualified 529 plan expenses. The portion of student loan interest that is eligible for the student loan interest deduction is reduced by the earnings portion of the tax-free 529 plan distribution that pays of student loans.
The law includes an aggregate lifetime limit of $10,000 in qualified student loan repayments per 529 plan beneficiary and $10,000 per each of the beneficiary’s siblings. Siblings may include a brother, sister, stepbrother or stepsister. A 529 plan account owner may change the 529 plan beneficiary at any time without tax consequences.
Since there are no time limits imposed on 529 plans, the student may keep contributing to a 529 plan throughout college or after graduation and use any leftover funds to repay student loans tax-free.
The expansion also presents an opportunity for grandparents who want to help a grandchild pay for college without affecting financial aid eligibility. Distributions from a grandparent-owned 529 plan are considered untaxed student income on the Free Application for Federal Student Aid (FAFSA) and can reduce a student’s financial aid package by up to 50% of the value of the distribution. Grandparents can avoid this by waiting until January 1 of the student’s sophomore year of college (when it will no longer affect untaxed income on the FAFSA) to take a 529 plan distribution or wait until the student graduates to pay down their student loans.
Past Proposals to Allow 529 Plans to Repay Student Loans Tax-Free
There have been several legislative proposals to treat student loan payments as a qualified higher education expense for 529 college savings plans:
- On July 24, 2018, Rep. Kevin Brady (R-TX-8), who is chairman of the House Ways and Means Committee, proposed allowing borrowers to use 529 plan funds to pay off student debt as part of Tax Reform 2.0. Subsequent legislation, which passed the House, would limit the use of 529 plan money to repay student loan debt to $10,000 per borrower. This legislation, the SECURE Act, is likely to pass Congress, due to overwhelming bipartisan support.
- On January 13, 2017, Rep. Lynn Jenkins (R-KS-2) and Rep. Ron Kind (D-WI-3) introduced the 529 and ABLE Account Improvement Act of 2017, which would have allowed 529 plan distributions to make payments on qualified education loans without the 10% tax penalty on non-qualified distributions. The distributions would still be subject to ordinary income taxes on the earnings portion of the distribution.
- On April 15, 2010, Rep. Melissa L. Bean (D-IL-8) introduced the College Savings Flexibility Act of 2010, which would have allowed payments of principal and interest on qualified education loans as a qualified 529 plan distribution from 2010 through 2014, inclusive. The goal was to allow families to delay taking distributions from their 529 plans after the large stock market losses of 2008 and early 2009. The legislation was never reported out of committee.