Great New Option to Reduce Student Loan Debt

Newly passed tax law could benefit many

Deep inside legislation passed in late 2019, is a provision that broadens the acceptable use of 529 college savings plan funds.

Background

529 savings plans are available to set aside after-tax funds to pay for college and K through 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.

The new rule

To help students financially after graduation, leftover 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 their siblings. For example, parents who have 4 kids 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.

Ideas to use this new rule

The graduation gift. 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 to reduce the loan balances. What a graduation gift!

The planning tool. Suppose parents or grandparents have two students who can use 529 funds. Now you 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 if need be the excess funds can be used to transfer to the other student who is a qualified beneficiary. When the students are done with school, any excess funds can be used to pay down loans for both students.

Flexibility. Many 529 plan holders would like to take advantage of using the funds to help pay for K through 12 expenses. With this extra use flexibility, it may make sense to use the funds early in your student's education.

Given the recent changes in 529 college savings plans, it makes a lot of sense to explore your options and either consider setting up an account or developing a plan for best uses of the funds in your accounts.