You Can Now Use Your 529 Plan to Pay Off Student Loans

Nadav Shemer
529 Plan to Pay Off Student Loans
In good news for student debt holders, you can now pay up to $10,000 of your balance out of a 529 savings plan without being taxed. The new rules came into effect on January 1, 2020 with the implementation of the federal SECURE Act. But there is a catch: some states may not recognize the tax deduction.

What is a 529 Plan?

A 529 plan is a tax-advantaged savings plan designed to help save money for future education expenses. It may be established by anyone, including non-relatives, for a designated beneficiary. 529 plans were originally created to allow people to save for higher education. A couple of years ago, Congress added K-12 public, private, and religious school tuition to the list of qualified expenses for 529 plans. Now it has added student loan debt to the list.

There are two types of 529 plans: prepaid tuition plans and education savings plans. All 50 states and the District of Columbia sponsor at least one type of 529 plan. A prepaid tuition plan lets a person purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and fees at current prices. An education savings plan lets a saver open an investment account to save for future qualified higher education expenses – tuition, mandatory fees, and room and board. 

The Securities and Exchange Commission offers a full rundown of both types of 529 plans here.

How Do the New 529 Rules Benefit Student Debt Holders?

Holders of 529 plans are under no obligation to use the money for the purpose for which it is intended by law, but you lose the tax benefits if you don’t. Before this year, you could use savings from a 529 plan to pay direct higher education costs such as tuition and mandatory fees, but you couldn’t use it to pay off loans. That all changed with the passage of the SECURE Act, which lets holders of 529 plans withdraw up to $10,000 toward paying off a student loan balance – all of it tax-deducted.

As we mentioned earlier, holders of 529 plans can name anyone as a beneficiary. Therefore, this law provides an incentive for parents, spouses, and others to assist loved ones in paying off their student loan balance. Or you might consider contributing toward your own 529 plan with the intention of using the savings to pay off student debt later on.

The One Catch: Not all States Recognize the Deduction

As is often the case with federal tax rules, not all states will recognize the changes to the 529 tax code. Some states will automatically follow the federal definition, but others may pass supplemental laws and say the money is only for repaying college and not student loans, says Mark Kantrowitz of SavingforCollege.com. 

More than 30 states offer income tax benefits for 529 plan contributions. But, depending how your state interprets the SECURE Act, you may face the risk of having those tax benefits reversed or of being slapped with extra income taxes and penalties if you use your 529 savings to pay down student loans, CNBC notes. It all depends on whether your state accepts student loan payments as a qualified higher education expense.

A Few Points to Consider

Before taking action on your 529 plan, here’s a checklist of things to consider:

  • Is there a net tax benefit? Just because the law says there’s a tax benefit doesn’t mean there’s a net benefit for you. It all depends how your state treats the new rules. We recommend consulting an accountant or financial advisor for help weighing up the pros and cons of using a 529 plan on your loan balance. 
  • Is this the best use of your 529? By law, you may pull money from your 529 to pay for any of the following qualified expenses: higher education, K-12 education, apprenticeships, home schooling, and student loans. Again, you may want to consult a financial advisor about the best use of your 529 savings.
  • Is this the best way to pay down your student loan balance? When it comes to managing student loan debt, there are more options on the table than you might realize. These options include refinancing with a private lender, refinancing through a state government (available in 12 states), income-driven repayment, and loan forgiveness for public servants.

Growing Recognition of Student Debt

Student debt is a big issue in America, impacting an estimated one in five adults. The changes to the 529 rules, along with other recent changes to the rules governing student loan payments, point to growing recognition of the student debt problem and an increasing willingness among lawmakers to ease the burden of paying off student debt. And that’s gotta be a good thing for student debt holders.

Want to ensure you pay off your student debt the right way? Check out our list of the best student loan refinance lenders, today.

Nadav Shemer
Nadav Shemer specializes in business, tech, and energy, with a background in financial journalism, hi-tech and startups. He enjoys writing about the latest innovations in financial services and products.