Janice Lozano
529 plans are a type of tax-advantaged savings account designed to help students and parents deal with the spiralling costs of education. While they were originally intended for college expenses, legislative changes have expanded their use to include K-12 education, trade schools, apprenticeships, and student loan repayment. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free 529 distributions of up to $10,000 per individual to repay a beneficiary's student debt, including that of their siblings. This has provided much-needed flexibility for graduates to pay down college costs and incentivised new graduates to pay down their loans without sacrificing retirement savings.
| Characteristics | Values |
|---|---|
| Legislative changes | The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free 529 distributions to pay off student loan debt for the designated beneficiary and their siblings, up to a lifetime maximum of $10,000 per person. |
| Tax advantages | 529 plans are tax-advantaged college savings vehicles. They allow you to avoid federal and (usually) state income taxes on the account's earnings, provided withdrawals are used for qualified education expenses. |
| State income tax breaks | If you live in a state that offers a state income tax break on contributions to the state's 529 plan, you can get a discount on student loans by contributing to the state's 529 plan and then taking a qualified distribution to repay the loans. |
| Non-qualified expenses | In some states, the distribution to pay student loans may be considered a non-qualified expense. Non-qualified distributions are subject to income taxes and a 10% penalty. |
| Leftover funds | After paying off student loan debt, any leftover 529 money can help with a child's retirement funding. |
| Timing of college bills | If the stock market is uncooperative with the timing of college bills, it may be best to borrow to pay the bursar's bill and leave the 529 plan funds invested. Then, after an economic recovery, use the 529 plan money to repay the student loans. |
| Student incentives | A student may be incentivised to graduate on time and get good grades if their parents or grandparents offer to pay down their student loans through a 529 plan. |
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What You'll Learn
Student loan interest tax deduction
If you’re facing student debt, the student loan interest tax deduction can help with your bottom line as you’re repaying your loans. Student loan interest is the cost of borrowing money to pay for your education. When you take out a student loan, you agree to repay the loan amount (the principal) plus interest, which is calculated as a percentage of the unpaid principal balance.
Federal student loan borrowers could qualify to deduct up to $2,500 of student loan interest per tax return per tax year. As long as your student loan qualifies, you can claim the student loan interest tax deduction as an adjustment to income. You don’t need to itemize deductions to claim it.
To qualify for the deduction, the following must apply:
- You paid interest on a qualified student loan in the tax year.
- You're legally obligated to pay interest on a qualified student loan.
- Your filing status isn't married filing separately.
- Your modified adjusted gross income (MAGI) is less than a specified amount, which is set annually.
- Neither you nor your spouse, if filing jointly, were claimed as dependents on someone else's return.
If you paid $600 or more of interest on a qualified student loan during the year, you should receive a Form 1098-E, Student Loan Interest Statement from the entity to which you paid the student loan interest.
In addition to the student loan interest tax deduction, there are other ways to use 529 plans to pay student loans. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free 529 distributions for the purpose of repaying a beneficiary's student debt, up to a lifetime limit of $10,000. The SECURE Act also allows for additional withdrawals of up to $10,000 for each of the beneficiary's siblings.
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State income tax break
State income tax rules vary, so it's important to check the rules in your state. Over 30 states, including Washington, D.C., offer a state income tax deduction or credit for contributions to a 529 plan. In most cases, you need to contribute to your own state's plan to receive the tax benefit. However, nine tax parity states offer a state income tax benefit for contributions to any 529 plan, not only in-state plans.
The amount you can deduct from your state income tax will depend on where you live and how much you contribute to a 529 college savings plan during a given tax year. Most states with income taxes allow either a deduction from income or a state tax credit for 529 plan contributions when reporting income for state tax purposes. Some states, such as New York, allow an annual state income tax deduction for 529 plan contributions up to $5,000 ($10,000 if married filing jointly). In other states, such as New Mexico, South Carolina, and West Virginia, 529 plan contributions are fully deductible when computing state income tax.
It's important to note that contributions to a 529 plan are not deductible on your federal income tax return. However, 529 plan contributions grow federally tax-free, and earnings are not subject to federal income tax when you take withdrawals for qualified education expenses. Additionally, funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary's family.
By taking advantage of the state income tax deduction or credit, you can reduce your tax liability and keep more of your money working for you in the 529 plan. This can help you save for college and other qualified expenses more efficiently.
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Penalty-free withdrawals
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free withdrawals from 529 plans for the purpose of repaying a beneficiary's student debt, up to a lifetime limit of $10,000. The SECURE Act also allows for additional withdrawals of up to $10,000 for each of the beneficiary's siblings. For example, a family with three children could withdraw a total of $30,000. However, it is important to note that the portion of student loan interest paid by these distributions is ineligible for the student loan interest tax deduction for regular income taxes.
The SECURE Act made it so that 529 funds can be withdrawn to repay the beneficiary's student debt or that of their siblings, limited to a $10,000 per individual lifetime maximum. This means that if you have more money in your 529 account than expected, you can withdraw up to $10,000 without incurring any penalties. This is a significant change, as prior to the SECURE Act, withdrawals for non-qualified education expenses were subject to taxes and a 10% penalty.
It is worth noting that certain exceptions let you take funds out of a 529 plan for non-qualified expenses without penalty, such as withdrawing an amount equivalent to a scholarship. Additionally, if the student wins a qualified scholarship, the 10% tax penalty is waived on a non-qualified distribution up to the amount of the scholarship. Similarly, veterans' educational assistance or employer-paid educational assistance can qualify for a tax penalty waiver.
In some cases, it may be beneficial to borrow money to pay for college expenses and leave the 529 plan funds invested. This way, you can take advantage of the potential for growth over time and use the 529 plan funds to repay the student loans at a later date. Additionally, if you live in a state that offers a state income tax break on contributions to the state's 529 plan, you can get a discount on your student loans by contributing money to the state's 529 plan and then taking a qualified distribution to repay your student loans.
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Tax-free distributions
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free 529 distributions for the purpose of repaying a beneficiary's student debt, up to a lifetime limit of $10,000. The SECURE Act also allows for additional withdrawals of up to $10,000 for each of the beneficiary's siblings. This means that a family with three children could withdraw a total of $30,000. However, it's important to note that the portion of student loan interest paid by these distributions is not eligible for the student loan interest tax deduction for regular income taxes.
The SECURE Act made it possible to use 529 funds to repay the beneficiary's student debt or that of their siblings. This expansion of 529 plans allows for more flexibility, especially when it comes to using the money to pay down college costs after a student has graduated. The act specifies that using a 529 plan for paying principal or interest on any qualified education loan, not exceeding $10,000, is considered an eligible distribution for state income tax deduction purposes.
Prior to the SECURE Act, any withdrawals for student loan payments would have been subject to income taxes and other penalties. Now, 529 plans can be used to pay off student loan debt, and the tax advantages of these plans help stretch savings further. This is because 529 plans are tax-advantaged college savings vehicles, allowing individuals to avoid federal and (usually) state income taxes on the account's earnings, as long as withdrawals are used for qualified education expenses.
It's worth noting that the American Opportunity Tax Credit (AOTC) is worth more per dollar of qualified expenses than a tax-free distribution from a 529 plan. Therefore, families should allocate up to $4,000 in qualified expenses to be paid with cash or student loans instead of a 529 plan distribution to qualify for the maximum AOTC. Additionally, in some states, the distribution to pay student loans may be considered a non-qualified expense, so it's important to check the rules of your state.
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Qualified expenses
A 529 plan is a powerful tool for saving for education that offers tax-free withdrawals on qualified expenses. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 made it so that 529 funds can be withdrawn to repay the beneficiary's student debt (or that of their siblings), limited to a lifetime maximum of $10,000 per individual.
Qualified higher education expenses for 529 plans include tuition fees for K-12 schools, as well as additional K-12 expenses such as books and materials, tutoring, exam fees, and more. The funds you accumulate in a 529 plan can be used to pay the full amount of your tuition and fees. The definition of 529 qualified expenses has been expanded to include professional training such as apprenticeships, credentialing and certification programs, and continuing education programs.
You can use a 529 plan to pay for qualified room and board expenses, including on-campus housing, off-campus rent, and meal plans, as long as the beneficiary is enrolled at least half-time. For off-campus housing, qualified expenses are limited to the college's cost of attendance allowance. Room and board for approved study-abroad programs and summer rent for half-time students also qualify.
You may use your 529 plan to purchase a computer, "peripheral equipment" (like a mouse or speakers), and internet access as required for attendance at a post-secondary college or other institutions. However, computer software that has nothing to do with your studies doesn't count as a qualified expense. That means computer games, sports software, or any apps related to a hobby can't be paid for using a 529 plan.
It's important to note that your state's definition of qualified expenses for state tax purposes may differ. In some states, the distribution to pay student loans may be considered a non-qualified expense. The 529 plan account owner should check their state's rules.
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Frequently asked questions
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows for penalty-free 529 distributions for the purpose of repaying a beneficiary's student debt, up to a lifetime limit of $10,000.
Yes, using a 529 plan to pay off student loans avoids both the tax penalty and the income tax on the distribution.
Yes, the SECURE Act also allows for additional withdrawals of up to $10,000 for each of the beneficiary's siblings.
Yes, 529 plans can also be used to pay for K-12 tuition, trade schools, and other qualified programs.
