Tax-favored savings accounts known as 529 plans can help families save and invest to pay for college. But until now, the funds could not be used to repay student debt.
That changed as part of the Secure Act, a law attached to broader federal spending legislation enacted in December. The law was aimed mainly at adjusting the nation’s retirement system, but it also expanded allowable uses for 529 funds.
Under the new rules, up to $10,000 from a 529 account can be used to repay the beneficiary’s student loans. Plus, up to another $10,000 each can be used to repay student loans held by the beneficiary’s siblings. (If, say, a student had two siblings with student loans, another $20,000 total could be withdrawn, without penalty, to pay their debt.)
The new law also allows 529 funds to be used to pay for apprenticeships, which typically combine on-the-job training with classroom instruction, often at a community college. To qualify, the apprenticeship must be registered with the federal Labor Department.
The update is the latest expansion of permissible uses for the state-sponsored college savings plans. As of 2018, up to $10,000 a year per student can be used to pay for pre-college school tuition from kindergarten onward.
Money is contributed after taxes to 529 accounts, grows tax deferred and is withdrawn tax free when used for eligible expenses. (There is no federal tax deduction for 529 contributions, but some states offer tax breaks.) Earnings withdrawn for ineligible costs are subject to income tax, plus a penalty.
Before the recent spate of changes, 529 savings plans were limited to paying for costs like tuition, fees, housing, meal plans, books and supplies.
“We’re really excited about giving families more options for how they can spend their 529 funds,” said Michael Frerichs, the chairman of the College Savings Plans Network, a group that promotes the state-sponsored plans.
The inclusion of apprenticeship costs, in particular, may relieve some families’ concerns that opening a 529 fund may be a disadvantage if their child decides not to attend college, Mr. Frerichs said.
The new option for loan payments may seem odd because the main goal for saving in a 529 account is to avoid borrowing for college in the first place. And 529 rules allow an account’s beneficiary to be changed to another family member at any time. So extra cash can easily be reallocated to another student to help pay for college expenses.
But despite the best-laid plans, families — especially those with multiple children attending college — may find themselves with both “leftover” 529 funds and student loans, said Mark Kantrowitz, publisher of Savingforcollege.com. He recently discussed strategies for using 529 funds to pay student debt.
The new loan payment option can help in multiple situations — some of which may seem complex but are relatively common, Mr. Kantrowitz said. Say a family has several children, each with a separate 529 account. If a younger sibling attends a less expensive college and does not need the full balance in the account, the family could use the money to help pay down the student debt of the older sibling.
Students could also end up with “excess” 529 money if they graduated from college in three years instead of four, perhaps by taking summer courses or earning advanced-placement credit.
Students may also have to borrow unexpectedly, say, if generous grandparents mistakenly run afoul of federal student aid rules, Mr. Kantrowitz said. Money saved in a grandparent-owned 529 account does not affect a student’s financial aid eligibility while sitting in the account. But once withdrawn, the “distribution” counts as student income and can reduce the student’s eligibility for need-based aid by as much as half of the withdrawal. (Grandparents often own the accounts in their own names so they can meet the requirements for income tax deductions offered by some states for 529 contributions.)
One way to avoid that happening is to wait until January of a grandchild’s sophomore year to withdraw funds, Mr. Kantrowitz said. Because the federal aid application uses income from the prior two years, waiting will mean that no subsequent year’s financial aid eligibility will be affected (assuming the student graduates in four years). The student may have to borrow for the first three semesters. But later, under the new rule, $10,000 from the grandparents’ 529 fund can be used to help repay the debt.
“The Secure Act,” Mr. Kantrowitz said, “provides families with greater flexibility in spending 529 plan money.”
The College Savings Plans Network says there are about 14 million open 529 accounts holding an average of $25,000 each.
The average student loan burden for college graduates with debt is about $30,000. So $10,000 from a 529 account by itself is not going to solve the student loan problem, said Carrie Warick, director of policy and advocacy for the National College Access Network, a nonprofit group that advocates on behalf of low-income students. “If you have significantly greater than $10,000 in loans,” she said, “it’s not a game-changer.”
Here are some questions and answers about the new 529 rules:
Can I use 529 money to repay private student loans, as well as federal loans?
The provision applies to federal and most private student loans.
Can I use 529 funds to pay an education loan I took out for my child?
The Secure Act’s provisions apply to student loans held by the 529 account’s beneficiary or the beneficiary’s siblings. But there is a workaround, Mr. Kantrowitz said. For example, a parent, as the owner of a 529 account with a child named as the beneficiary, could make a change and designate himself or herself as its beneficiary and take a $10,000 distribution to repay federal or private parent loans.
Depending on how much money was left in the account, the family could first use $10,000 to repay a child’s loans and another $10,000 for a sibling’s loans, before making the beneficiary change and taking a distribution to repay the parent loan, he said.
When do the new 529 rules take effect?
The new 529 rules are retroactive to the beginning of 2019. But account holders may want to be cautious and check with their own 529 plan before withdrawing funds. The new rules are in effect for federal tax purposes, but it’s possible that some state 529 programs will not follow along and recognize student loan payments or apprenticeship costs as eligible expenses. (That happened with the earlier change that allowed 529 funds to be used to pay for pre-college education costs.) Account holders in states that do not go along with the new federal rules may be subject to state income taxes and penalties, or possibly a repayment of state tax breaks. The various 529 plans are evaluating the new law, Mr. Frerichs said, and it could be weeks or months before the issue is settled in each state.
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