Student loan debt has become one of the largest classes of consumer debt in the country. In fact, it affects as many as 43 million Americans. According to a report from Forbes, student loan debt reached almost $1.5 trillion in early 2019, with the average borrower from the class of 2018 owing as much as $29,200 in student debt.
Finding the money to pay down student loans—let alone pay for school—is a struggle for many new grads who are just starting out in the workforce. Loan forgiveness programs can offer some relief, but only for borrowers who work in selected fields. But there’s a plan in place that not only helps people save for tuition and other expenses tax-free; it also helps them pay a portion of their student loans—or those of their beneficiaries—without penalties.
529 Education Savings Accounts started as a tax-free vehicle to help pay for qualified higher education expenses, such as tuition, room and board, and computer software and equipment. In 2017, the rules were expanded allowing parents to withdraw up to $10,000 a year from 529 plans to pay for K-12 tuition at public, private, and religious schools. Now, it’s expanded again allowing you to take tax-free withdrawals from a 529 account to pay toward student loans.
There’s a lifetime limit of $10,000 per beneficiary from 529s to pay down student loans. It applies to federal student loans and most private ones. There is a $20,000 maximum lifetime withdrawal from 529 plans to pay student debt no matter how many children you have. For example, if you have two children, you can withdraw $10,000 to pay toward student debt for each child. If you have three children or more, $20,000 is still the maximum lifetime deduction from 529s to go toward student debt. You cannot deduct any student loan interest paid with those withdrawals.
- Decide how much you want to withdraw up to $10,000 per beneficiary.
- Find out if your state considers student loans as a qualifying expense for a 529 account. Even though the federal government says 529 money can be used toward student loans, not all states have the same provision. Whether the 529 plan is sponsored by the state you live in or another state, find out if the state’s definition of a qualifying education expense includes paying student debt.
- Then make the withdrawal and apply it to the student loan. The loan payment must be made in the same year you withdraw the money. Keep proof of the withdrawals and proof of the loan payment.
Sometimes there’s money left in a 529 account after a child finishes college. In that case, you can name someone else in the family as beneficiary of that account—another child, or yourself or your spouse if you intend to go back to school for additional education. As long as the money is spent on qualifying educational expenses, it comes out of the 529 plan tax-free.
You can always withdraw money from 529 education savings accounts for things that are not education related. If you do, you’ll pay federal and state tax on those withdrawals along with a 10% IRS penalty. But there’s no requirement that you withdraw money left in a 529 plan. You can leave it there as long as you want until you decide what you want to do with it.
This article is presented as information only and should not be considered tax, legal or financial advice.