Table of Contents

    Can I Use My 529 Plan To Pay Back My Student Loans?

    One of the largest consumer debt groups in the United States is student loan debt. With one out of five Americans owing payments, the number of people looking for alternative ways to pay off their loans is increasing by leaps and bounds.

    Luckily, for debtors, the SECURE (Setting Every Community Up for Retirement) Act is now a law. Henceforth, you can use your 529 savings plan’s interest and principal payments to pay student loans.

    What Does a 529 Plan Mean?

    A 529 college savings plan is a college savings program providing tax and financial assistance incentives. It was initially intended to cover the costs of post-secondary education of the beneficiary. In 2017, the Tax Cuts and Jobs Act was signed, and the plan was approved to cover K-12 education and other qualified education expenses.

    There are two types of 529 plans—savings and prepaid plans. Prepaid plans allow you to prepay school and other expenses for the beneficiary, provided that they are enrolled in a qualified college. Savings plans, on the other hand, mimic individual retirement accounts (IRAs) as they are tax-advantaged investments.

    The concept of eligible higher education spending was extended in 2015 to include computers, in 2017 to include up to $10,000 a year in K-12 tuition expenses. In December 2019, the Trump Administration passed the SECURE act, which further expanded the benefits of a 529 plan.  The SECURE Act broadens the scope of eligible higher education spending to include student loan payments and apprenticeship expenses, providing more choices for families.

    Under the new act, you can use a maximum of $10,000 to pay a portion of the student loan. Besides Federal tax-free growth along with tax-free deductions for eligible expenditures, many states also provide people with a full or partial tax credit or a deduction for contributions to the plans. However, keep in mind that the tax benefits vary by state.

    You can join the 529 plan for any state, not just the one you hail from. All of the 529 plans can be used to pay for college expenses at any eligible college across the country. You can use the 529 savings for tuition and other qualified academic expenses at more than 6,000 US colleges and universities and more than 400 international colleges and universities.

    What Has The SECURE Act Added To The 529 Plan?

    There have been some improvements as to how 529 plans can be used by plan holders thanks to the passage of the Setting Every Group Up for Retirement Enhancement (SECURE) Act in 2019. As long as the program meets a few specific requirements, Federal tax law allows for special tax incentives, such as a 5-year contribution tax average and tax-free eligible distributions.

    The SECURE Act has a lifetime limit of $10,000 in qualifying student loan repayments per beneficiary and $10,000 for each of the beneficiary's siblings. With the new act in place, you can now:

    - Use the approved limit from your 529 savings plan to cover the costs of any qualified apprenticeship. This includes add-on expenses like books, supplies, equipment, fees, and more.

    - You can withdraw a maximum of $10,000 to pay down eligible pending student loans. Additionally, you can also use $10,000 for each sibling. So, if you’ve got two kids studying in college, you can use $20,000 to meet their student loan repayments. Better yet, these withdrawals are tax-free.

    - You can’t claim deductions on the student loan interest when you make payments using the 529 account’s funds.

    The legislation also offers a new way for grandparents to help grandchildren pay for college without impacting the availability of financial aid. Normally, contributions from the 529 grandparent-owned fund are listed as non-taxed income on a student's Free Application for Federal Financial Aid (FAFSA). The student financial aid plan can now be decreased by up to 50% of the amount of the non-taxed income.

    Like the Roth IRA, contributions to the 529 program are post-tax and are not deductible from federal income taxes. However, more than 30 states and the District of Columbia provide State income tax deductions or tax incentives for donations to 529 plans, but you may be limited to participating in the 529 plan in your home state to receive the gain. Funds under the 529 program are tax-free and you won’t be taxed if the money is withdrawn for eligible college expenses.

    Notable Benefits Of The 529 Plan

    Other than being tax-free, 529 plans offer several other prime benefits. For starters, you can open as many 529 accounts as you want, both in your state of residence as well as neighboring states. Secondly, the control of the account is solely with the parent or guardian and not the beneficiary.

    Besides these advantages, everyone is eligible to contribute to a 529 plan. There are no income phase-outs or age capping on contributions. You get higher-aggregate contribution limits, usually between $235,000 to $520,000 depending on the state.

    Furthermore, there is no deadline on using the funds from a 529 plan. You can use it as and when required to pay eligible expenses like undergraduate or graduate school fees and medical or law school expenses.

    Bottom line

    Investing in a 529 plan is one of the wisest financial decisions for your children’s future. You can apply for a 529 plan directly or open one through a financial advisor. However, we recommend that you first check the state laws and the list of qualified colleges and universities before opening a 529 college savings plan.