How to Use Your 529 Plan to Pay for College in the Pandemic

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Mark Kantrowitz

By Mark Kantrowitz

October 14, 2020

During the coronavirus pandemic, the stock market has been chaotic, with wide swings in the value of investments from one day to the next. If your child is enrolled in college or about to enroll in college, what is the best strategy for using your 529 plan to pay for college?

Stock Market Gyrations

The S&P 500 dropped by a third (34%) from February’s peak to March’s low point. Since then, the stock market has recovered 60% as of early September and subsequently gave back some of those gains, but is still up by more than 9% year-to-date. 

So, some investors in 529 plans may be in positive territory and some may be in negative territory. A lot depends on the account owner remained invested or made some changes.

How to Use a 529 Plan to Pay for College with Student Loans

If you need to pay college bills now, but want to remain invested, what are your options?

One option is to borrow the money to pay for college and use 529 plan money later to repay the debt. 

The SECURE Act allows qualified distributions from a 529 plan to repay up to $10,000 in federal and private student loans per borrower. This is a lifetime limit per borrower. 

Thus, you could pay for college using student loans this year, and use your 529 plan to repay the student loans next year.

But, be sure to check with your 529 plan whether the state conforms to federal law with regard to student loans. Some states treat student loan repayment as a non-qualified distribution from a 529 plan. If so, you may owe state income tax on the earnings portion of the distribution. 

Also, using a 529 plan to repay student loans may affect your eligibility for the student loan interest deduction, since coordination restrictions prevent you from claiming the student loan interest deduction based on amounts repaid with a 529 plan distribution. 

If you borrow student loans, keep in mind that federal student loans often provide superior benefits than private student loans. If you’ve decided a private loan is right for you, check out our list of the best private student loans.

Timing Matters

An alternative is to use your 529 plan to pay for college, but to delay the distribution until the last minute.

For a distribution from a 529 plan to be considered a qualified distribution, it must be used to pay for qualified expenses in the same tax year as the distribution.

So, you can pay the college bills now using other money, then reimburse yourself using a 529 plan distribution near the end of the tax year. 

Just be careful to allow time for the 529 plan program manager to make the distribution. If you wait until the last day of the tax year to make the distribution, it might be recorded as occurring in the next year. It is best to request the distribution at least two weeks before the end of the year, given that the winter holidays may add delays to the process. 

Make Distributions from the Cash Portion of Your 529 Plan

If a 529 plan is in an age-based asset allocation or enrollment date portfolio, typically less than 20% of the 529 plan funds will be invested in stocks when the child enrolls in college. The rest will be invested in bonds and cash. Further stock market gains will have a minimal impact on the value of your 529 plan.

But, if you manage your asset allocation manually, part of your 529 plan may be invested in cash or bonds. Most 529 plans will let you take the distribution from specific portfolios. So, you can choose to remain invested in stocks, taking the distribution from the cash and bond portion of your 529 plan. 

Taking the distribution from the cash and bond portion of your 529 plan, however, will shift the 529 plan to a higher-risk mix of investments. The stock portion of the 529 plan will remain unchanged while the cash and bond portion decreases, yielding a higher percentage of equities.

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