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Senator Rand Paul (R-KY) introduced legislation on December 2, 2019 to allow tax- and penalty-free distributions from retirement plans to pay higher education expenses and to repay student loans starting in 2020. The Higher Education Loan Payment and Enhanced Retirement (HELPER) Act (S. 2962) will also expand the student loan interest deduction and exclude up to $5,250 in employer-paid student loan repayment assistance programs (LRAPs) from the employee’s income.
Congress is unlikely to consider the HELPER Act this year.
Tax-Free Distributions from Retirement Plans
Distributions of up to $5,250 per year from 401(k), 403(b) and 457(b) retirement plans and unlimited distributions from IRAs will be excluded from income if used to pay for qualified higher education expenses and to repay student loans. The 10% tax penalty will also be waived on these distributions.
The taxpayer does not need to demonstrate financial hardship for the distributions to qualify for tax- and penalty-free treatment.
Qualified higher education expenses are the same as for 529 plans, but with the addition of student loans. Thus, qualified higher education expenses include tuition, fees, books, supplies, equipment, special needs expenses, purchase of a computer (including peripherals, software and internet access), room and board (if the student is enrolled at least half-time) and repayment of student loans.
The qualified higher education expenses are limited to expenses made for the taxpayer, the taxpayer’s spouse or the taxpayer’s children at an eligible educational institution. Eligible educational institutions are limited to institutions of higher education that are eligible for Title IV federal student aid. This excludes K-12 schools from the definition.
Employer-Paid Student Loan Repayment Assistance
The HELPER Act would amend the law excluding up to $5,250 in annual employer-paid educational assistance from income to include employer-paid student loan repayment assistance within the definition of educational assistance.
Thus, employees could receive a combination of up to $5,250 per year in student loan and tuition payments from their employers, tax-free.
Expansion of Student Loan Interest Deduction
The HELPER Act will repeal the cap on the student loan interest deduction. Currently, the student loan interest deduction is limited to $2,500 in interest paid on federal and private student loans.
Excess interest that exceeds the taxable income of the taxpayer could be carried forward to subsequent tax years.
The HELPER Act will also eliminate the income phaseout on the student loan interest deduction. Currently, the student loan interest deduction begins phasing out at modified adjusted gross income of $70,000 for single filers and $140,000 for married filing jointly.
Increase in Retirement Plan Contribution Limits
The HELPER Act will increase the annual contribution limits for 401(k), 403(b) and 457(b) retirement plans from $19,500 (current 2020 limit) to $25,000.
This will allow taxpayers to contribute an extra $5,500 per year for college savings or retirement.
Comparison with 529 Plans
If the HELPER Act is enacted, it may contribute to an increase in retirement plan contributions. But, the legislation may also cause a decline in 529 plan contributions. If retirement plans are used to pay for college costs, parents may be left with less money for retirement.
On the other hand, if parents are unsure whether their child will go to college, the parents can save the money for college in a retirement plan. If the child does not go to college, the child gets a head start on saving for retirement. If they go to college, they can use the money after college to pay down their student loan debt.
There will be several other differences between using 529 plans and retirement plans to save for college, if the HELPER Act passes.
- Contributions to retirement plans will be made with pre-tax dollars, while contributions to a 529 plan are made with post-tax dollars.
- There are no limits on contributions to 529 plans, other than gift tax considerations, while contributions to retirement plans will be subject to annual limits.
- More than 30 states offer state income tax deductions and tax credits based on contributions to the state’s 529 plan, while there is no similar benefit for contributions to retirement plans.
- Tax-free distributions from 529 plans are limited to qualified higher education expenses, but student loan repayment does not currently count as a qualified expense. (The SECURE Act, which has passed the House and is stalled in the Senate, would allow up to $10,000 per beneficiary in student loan repayment from 529 plans.) Tax-free distributions from retirement plans would also be limited to qualified higher education expenses, including student loans, but would also be capped at $5,250 per year.
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