Can you use a 529 to pay student loans?

Student loan debt affects a large portion of college students — 55% of 18- to 29-year-olds who graduate with a bachelor’s degree carry some form of student loan debt, with the average amount ranging from $20,000 to $24,999 in 2020, according to Federal Reserve data.

If you’re finding it difficult to make your student loan payments after you graduate, there’s some good news: The IRS now allows 529 plan holders to use those funds to pay for student loans. Keep reading to learn how to pay student loan debt with a 529 plan and some ways you can use any leftover 529 money.

• What is a 529 plan?
• Can you use a 529 plan for student loans?
• How to use a 529 plan for student loans
• Uses for leftover 529 money
• Consider refinancing to save money on your student loans

What is a 529 plan?

A 529 plan, also called a qualified tuition plan, is a type of tax-free savings account meant to help pay for qualifying education expenses. States, state agencies, and educational institutions can sponsor these plans, which come with tax benefits. The idea is that the account owner can help grow savings for their beneficiary to use for their future education, whether it’s for themselves, a child, grandchild, or spouse.

Two types of 529 plans are available:

• Prepaid tuition plans — These plans offer plan holders the ability to buy units or credits toward participating educational institutions for future tuition and mandatory fees. These plans allow you to save money on tuition by paying today’s prices before they go up when the beneficiary is ready to go to college. You typically can’t use this type of plan to pay for future room and board at a college or university, or to prepay for elementary or secondary school tuition.
• Education savings plans — Account holders can open an investment account specifically to save for a beneficiary's future qualified educational expenses. You can use the money invested for any qualifying educational expenses — tuition, fees, and room and board.

One of the main benefits of a 529 plan is that withdrawals are generally exempt from federal income tax, and often state taxes, as long as you use the money for qualifying educational expenses.

What is the SECURE Act?

The Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, enacted in 2019, changes how 529 plan holders can use funds toward new qualifying expenses — including student loan payments (more on that below).

Account holders can also use 529 funds to pay for expenses toward qualifying apprenticeship programs that the beneficiary attends, such as equipment, books, fees, and other supplies related to the apprenticeship.

The SECURE Act allows account holders to withdraw money for these purposes retroactively to Jan. 1, 2019.

Can you use a 529 plan for student loans?

Yes, you can use a 529 plan to pay for qualified student loans.

The SECURE Act allows account holders to use a lifetime limit of $10,000 per beneficiary to pay down student loans tax-free from their 529 plan — both federal student loans and most private ones.

So if you have multiple children, you can use up to $10,000 each for a child and their sibling toward their student loans — up to $20,000 total.

Prior to the SECURE Act, withdrawals for student loan payments didn’t count as qualifying educational expenses. That means if you used your 529 plan for this purpose, you were subject to a federal tax penalty of 10%. Plus, any earnings distributions counted as taxable income, which could have increased your tax liability.

How to use a 529 plan for student loans

If you want to use your 529 plan to pay for student loans, take these steps:

• Decide how much you want to pay. You can use up to $10,000 per beneficiary. To determine how much you want to withdraw, consider the current balance of the student loans you want to pay.
• Check whether your state considers student loans as a qualifying expense. Just because the federal government has expanded the definition of qualifying educational expenses to include student loans, doesn't mean your state has. Before making a withdrawal, contact your state to see whether its definition of qualifying educational expenses aligns with the federal definitions. If your 529 plan is from a different state than the one you live in, it’s also helpful to contact the state that holds your plan to see what its laws are and how it might affect your withdrawal.
• Make the withdrawal and apply it toward student loans. Once you've determined you can use 529 withdrawals toward student loan payments, follow the plan holder’s instructions for making a withdrawal. Then, pay the distribution toward the student loans — you’ll need to do this within the same calendar year you made the withdrawal. Make sure to keep proof you made withdrawals and ensure it matches up with the student loan payments.

Uses for leftover 529 money

Sometimes, families can have leftover money in their 529 plan. If this is the case, you can use any remaining money for another child’s college expenses.

Many plans allow you to change the beneficiary’s name, so if you have another relative, you may want to consider putting the 529 plan in their name. There’s nothing wrong with leaving the funds untouched until you know what you plan on doing with the money, or even waiting until after a bull market is over before using the remaining funds.

Consider refinancing to save money on your student loans

Student loan refinancing is another way to save money on student loans, especially if you can get a lower interest rate. If you extend your repayment term, you’ll likely end up with a smaller monthly payment (but you’ll also end up paying more interest over the life of the loan).

If you have federal student loans, think carefully before you refinance. Refinancing them into a private loan means you’ll lose access to federal benefits and protections, like income-driven repayment plans and student loan forgiveness programs.

That being said, the savings from refinancing your loans could be worth it in some cases. It’s a good idea to shop around and compare multiple lenders so that you can find the best student loan refinance for your situation.