A 529 savings plan is a special type of account that allows after-tax funds to be used to pay for college and K-12 education expenses. As long as the funds are used to pay for qualified expenses, any earnings or interest in the savings plan are tax-free. Any unused earnings on funds are subject to a penalty and income tax.
Late in 2019, legislation was passed that includes a provision that broadens the acceptable use of 529 college savings plan funds. Under this legislation, money in a 529 plan may now be used to pay off student loans. There is a $10,000 lifetime limit for the 529 plan’s beneficiary and each of the beneficiary’s siblings. For example, parents who have 4 children can take a $10,000 distribution from the 529 plan to pay student loans for each of their children, for a total of $40,000.
These new rules open new possibilities for using 529 savings plans in ways that weren’t permitted before, such as:
- Strategic use of student loans. If your student has access to low interest loans, you may wish to take out the loan now, in case your 529 plan funds are not enough to fund all four years of college. Then when your student graduates, you can use any excess funds to reduce the loan balances.
- Options for multiple students. Parents and grandparents who have two eligible students now have two choices: pay down debt or transfer funds to another beneficiary. With this new rule you can keep excess funds in place from the first student, then these excess funds can be transfered to the other qualified student if they are needed. When both students have finished school, any remaining funds can be used to pay down loans for both students.
Given these recent changes in 529 college savings plans, it makes sense to explore your options and consider setting up an account or developing a plan to make the best use of the funds in your existing accounts.