Whether You Should Save For Student Loan Debt
Its generally better to save for college expenses than accumulating and paying for student loan debt. For instance, lets say you are able to save $15,000 over the course of 10 years to help out with your childs college expenses. Plan for using that money to go towards tuition and fees, etc. Even if you think you may get a higher return by keeping the money in investments than the interest youd pay on student loans, its not guaranteed.
However, there are a few circumstances when it does make sense to use college savings plan to pay off student loans:
What Can 529 Plans Be Used For
Given their tax-free status and the returns they can generate, 529 plans are a favorite for those looking to pay for higher education, but their uses are strictly defined by plan administrators and federal law. Each of the three types of 529 plans â education savings plans, prepaid tuition plans, and ABLE accounts â have their own acceptable uses, known as âqualified distributions â weâll look at some of the acceptable uses of 529 plans below:
Requirements For A Qualified Loan
- Money has to be used for paying the qualified higher education expenses exclusively. This does not include mixed loans such as a credit card or house loan.
- Neither loans combined with financial aid nor other study loans that pass the limit are accepted
- A retirement plan is not a qualified loan.
- Loans from other people are not qualified.
- The loan application form has to be made within 90 days after the payment date. Allways for the college expenses
- The loan´s beneficiary has to be enrolled during the financial academic period. Because of this, loans for residence and relocation after graduation are not eligible.
- Continuity education and dual enrollment loans are not eligible
- Loans are for students enrolled in colleges and universities that can be chosen for receiving Federal aid but only for those who have the IV certificate.
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Pick The 529 With The Best Features
If you happen to live in a state that offers a tax deduction for contributions to its 529 plan, then choosing your state’s plan is one of the more obvious, but still valuable, 529 plan tips for you. Here’s how to find out if your state offers a 529 plan deduction.
Some states, however, dont dont offer a tax deduction when you contribute to a 529 account. Other states offer a tax deduction even if you choose a 529 plan outside of your state . The states that offer tax parity include: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania.If you live in a state in either category, theres no reason to pick a 529 plan in your state. Instead, it may make more sense to open a 529 account at a brokerage that offers a combination of the lowest fees and best investment options. These are the best brokers to open a 529 plan.
Plan Withdrawals Used To Pay Student Loans
The definition of qualified higher education expenses for 529 plans is expanded to include student loan repayment on any qualified education loan of a designated beneficiary or a sibling of the designated beneficiary . The amount is treated as a qualified expense for loans of any individual and is subject to a lifetime limit of $10,000. A designated beneficiary and a sibling would each be allowed up to $10,000 of qualified education loan repayments as 529 plan qualified distributions.
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. The provision does not appear to directly encompass the repayment of student loan debt incurred by parents on behalf of the designated beneficiary.
Note: Distributions outlined under these provisions are considered qualified under Kansas state statutes. Per KSA 75-643 Qualified higher education expenses means any qualified higher education expense included in section 529 of the federal internal revenue code of 1986, as amended. Consult a tax advisor about how these changes may impact your personal situation.
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Apply The Distribution To Your Student Loans
Timingis important to consider regarding your 529 withdrawal tax implications. Thewithdrawals you take from your 529 account must match up with the payment ofyour student loans in the same tax year.
If you withdraw the 529 money in December but dont make that student loan payment until January, you risk not having enough qualifying expenses during the year of the 529 withdrawal .
Likewise, if you take a distribution in January to pay for expenses from the previous December, that distribution will be a nonqualified distribution.
Whether You Can Amend Past Years Tax Returns
If you already filed your tax return for 2019, you can file an amendment if you paid a tax penalty for withdrawing money from your 529 plan and get a refund. However, the rule doesnt backdate past 2019. So you cant amend returns to get a refund if you withdrew money for student loan debt in 2017 or 2018.
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Can A 529 Plan Be Used To Pay Student Loans
529 plans are one of the most popular college savings options, but many people wonder if these funds can be used for college debt. Learn more from our 529 experts.
Even with the benefit of savings and financial aid, students across the country wind up with mountains of debt after finishing college, leaving many college grads to wonder how they can best pay off their student loans. As one of the most popular ways to prepare for college, 529 plans come with a raft of benefits, but do any of these benefits apply to students struggling with debt? If you have a 529 plan with funds left over after college, you might be wondering, âCan I use a 529 plan to pay off student loans?â To find out the answer, keep reading as the team at Sootchy addresses this important topic.
Can I Use A 529 Plan To Pay Off My Student Loans
Q. Can I use a 529 plan to pay off my student loans?
In debt
A. Thanks to the SECURE Act short for the Setting Every Community Up for Retirement Enhancement Act you can use a 529 plan to pay off student loans.
But of course there are limits.
The act expanded the definition of qualified education expenses for 529 plans to include student loan repayments, said Gene McGovern, a certified financial planner with McGovern Financial Advisors in Westfield.
The change is retroactive to Jan. 1, 2019.
McGovern said tax-free distributions from 529 plans can now be used to pay both principal and interest on student loans, but theres a $10,000 lifetime limit per person. This limit is not adjusted for inflation, he said.
To put that $10,000 number into perspective, outstanding student loan debt in the U.S. currently totals more than $1.6 trillion, he said. That debt is shared by about 45 million Americans, which averages out to about $36,000 each.
The ability to shave $10,000 off that average $36,000 loan with tax-free 529 plan funds, a 28 percent reduction, is therefore significant, McGovern said.
The news gets even better than that: Outstanding student loan debt for each of a 529 plan beneficiarys siblings can also be paid with up to $10,000 of plan funds, he said.
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Can I Use A 529 Plan To Pay Student Loans And Claim Both The State 529 Deduction And The Federal Student Loan Interest Deduction
At first blush, this sounds like it might be double-dipping. But let’s take a look at the new IRS rules.
As pointed out in another question, in the U.S. we can now use a Qualified Tuition Program to pay student loans as a qualified education expense – up to a lifetime maximum of $10,000 per person and provided your state accepts the new rules . The newly released IRS Publication 970 for the 2019 tax year provides some good information, but it glosses over certain details. I even called the IRS and tried to ask for clarification, and the rep admitted that she couldn’t find any answers because it’s still too new. I’ll periodically try to get the IRS to conjure up an official answer, but I’m hoping that someone can either shoot holes in my below scenario or provide additional support for it being valid.
From the 2019 Publication 970:
You cant deduct as interest on a student loan any amount paid from a distribution of earnings made from a qualified tuition program after 2018 to the extent the earnings are treated as tax free because they were used to pay student loan interest.
- $2500
- reported paid student loan interest
- total student loan payments minus QTP distribution earnings used to pay student loans
Determining the last number requires a bit of spreadsheet-fu but is doable to be able to prove that I’m not double-dipping per tax law. This makes the following scenario plausible:
How To Establish A 529 Account In California
California has one 529 plan that you can establish known as ScholarShare. This plan does not require the plan holder to reside in a certain state and allows the following people to open a plan:
- S. citizens
- Resident aliens that are at least 18 years old
- Emancipated minors
- UGMA/UTMA custodians
- Other legal entities
There are two types of 529 plan accounts that you can open: individual accounts and custodial accounts. An individual account is typically created by a parent for the benefit of their child. These plans are favorable because they allow various family members to contribute to the plan, like aunts, uncles, grandparents, and other relatives. Contributions to a 529 account could be made in several ways. For example, you could schedule payments from your bank account or deposit money via paper checks.
Individual accounts usually only require one parent to be the account holder. If possible, it would be wise for the account holder to be the childs biological parent.
If you are using money from a custodial bank or brokerage account to finance a 529 plan, it is advantageous to open a 529 custodial plan. A custodial 529 allows the child to serve as the plan holder and the beneficiary. While the child may be the account holder, a custodian will control the account until the beneficiary reaches the age of majority. It is important to note that once established, the beneficiary for a custodial 529 plan cannot be altered.
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Plans Now Allow Student Loan Withdrawals
- 529 Plans Now Allow Student Loan Withdrawals
529 college savings plans, tax-advantaged college investment accounts, are no longer just for paying for college. In the last few years, the IRS opened up the accounts to be able to be used for K-12 private school education.
Recently, a new rule was made by the IRS to add student loan repayment. Thus, families can now save for and pay off student loans with 529 college savings plans.
While it may not seem to make sense to save for student loans instead of just paying for college expenses, there are circumstances when this new rule would help families out a lot. For instance, your kid decided not to go to college, but you still have your own student loan debt. You can then withdraw money to pay off your student loan debt without paying a tax penalty.
If youre considering whether taking money out of yours or your childs 529 plan to pay for student loans, heres what you need to know:
Plans Can Repay Parent Loans Too
The account owner can change the beneficiary to a parent and use this to pay off up to $10,000 of parent education loans too. If each parent has borrowed parent loans, the account owner can change the beneficiary from one parent to the other to pay off that parents education loans.
Since the $10,000 limit is per borrower, it doesnt matter if the parent has parent loans for their children and student loans for their own education. The total of the qualified distributions is limited to $10,000 across all education loans.
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Use Student Loans To Pay For Non
Some college costs, such as health care and transportation costs, can not be paid for with 529 plan savings. However, a 529 plan beneficiary can take out student loans to cover these costs, and then take a 529 plan distribution to repay the student loans later. If the student loans are subsidized, the loan balance can be paid off before interest begins to accrue.
Minimizing Impact On Financial Aid
When someone other than the students parents helps pay for college, it can hurt eligibility for need-based financial aid. Some colleges treat such gifts as cash support or as a resource . Waiting until the student graduates to pay down student loans avoids the risk of a reduction in the students aid eligibility.
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Create New Student Loan Forgiveness Programs
Philanthropists and foundations can now use 529 plans to create tax-free student loan forgiveness programs, up to $10,000 per borrower. Instead of paying off the borrowers student loans directly, the loan forgiveness program would contribute the funds to a 529 plan in the borrowers name.
The $10,000 lifetime limit on loan repayment prevents abuse of qualified distributions to repay student loans, but also constrains legitimate uses of distributions to repay student loans.
The coordination restrictions with the student loan interest deduction also helps avoid abuse. The earnings portion of distributions to repay the taxpayers student loans will reduce the $2,500 annual limit on the student loan interest deduction. Of course, if the earnings portion of the distribution exceeds the $2,500 limit, the excess will not reduce the student loan interest deduction below zero.
How To Use A 529 Plan For Student Loan Repayment
Families can now use 529 college savings plans to pay off all or part of their student loans – for the most part.
The Setting Every Community Up for Retirement Enhancement Act of 2019 , also known as the SECURE Act, changed the definition of qualified distributions from a 529 plan to allow 529 plans to be used to repay the principal and/or interest on qualified education loans of the beneficiary and the beneficiarys siblings.
However, there are some rules and caveats you need to know before you start withdrawing from your 529 plan to repay your student loans. Let’s dive in.
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What The Rules Are For Withdrawing For Student Loan Debt
As long as the money was withdrawn from the 529 plan after 2018, you can withdraw up to $10,000 from your 529 plan account without paying a tax penalty. The federal tax penalty alone would have been $1,000 plus income tax on the part of the withdrawal that comes from earnings.
In order to withdraw funds tax free, the student loan debt has to belong to the beneficiary or the beneficiarys sibling. The beneficiary is whomever you listed as the person you are saving for. For instance, you may be savings for yourself, a grandchild, a niece or nephew, or your own child. You can change the beneficiary if you choose to do so. If you are withdrawing for anyones loans besides the sibling, this is necessary to not pay the tax penalty.
What To Do With A 529 College Savings Plan If Student Debt Is Forgiven
One of the ways families can spend their 529 college savings plan is to pay down student loans.
But what if that debt is forgiven?
It has been widely reported that President Joe Biden is leaning toward a plan of canceling $10,000 per borrower. An official announcement is expected from the White House later this summer. That amount of relief would entirely clear the balance of about 33% of student loan borrowers, or close to 12 million people.
Currently, 529 account holders can use up to $10,000 to repay student loans for both the plan’s main beneficiary and any siblings of the beneficiary. These state-sponsored investment plans allow parents to deposit money and then withdraw it tax-free, so long as the money is used for certain education expenses.
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Fortunately, families planning to use their 529 college savings for a student loan balance will be able to spend the money in a number of other ways, experts say.
“If you have leftover money in a 529 plan, you have several options,” said higher education expert Mark Kantrowitz.
For one, if a parent has a remaining student loan balance after the forgiveness, they can make themselves the account beneficiary and use the funds for their debt. They should just keep in mind that the cap of $10,000 is a lifetime limit.
Usually changing the beneficiary is as simple as contacting your plan and filling out a form, Kantrowitz said.
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Carefully Consider Your 529 Plan Withdrawals
In the end, you want to manage your withdrawals to minimize the 529 plan penalty. If possible, take steps to ensure that the money is used for qualified expenses, such as using a 529 to pay student loans off. That way, you avoid taxes on the earnings and stay away from the 10% penalty.
However, there are times when you might not be able to use the money for qualified education expenses. Or maybe you decide you need the money for something else if thats the case, it might be worth it to go ahead and accept the taxes and penalty to get access to the capital. You might use the funds to pay down other debt or accomplish another financial goal.
Consult with a financial professional as you weigh the pros and cons of 529 plans. That way, you understand the implications ahead of time and can make your best decision about using 529 plan money.
Andrew Pentis contributed to this article.
