The Weekly Scenario: Can I Use 529 Plan Funds To Pay Off Student Loan Debt?

Question: Can I use 529 plan funds to pay off student loan debt?

Answer: As a result of the SECURE Act that was signed into law on December 20, 2019, families with 529 college savings plans now have more options when it comes to using 529 funds.  Now you can use some of your 529 savings (previously only used for qualifying college expenses and K through 12 tuitions), to pay off student loan debt without incurring a penalty.

If you are lucky enough to have some ‘extra’ 529 plan funds after graduation, there is a way to use these funds before cashing out and paying a 10% penalty on the earnings.

However, this new perk does have limitations. For example, families with 529 college savings plans are limited to withdrawing up to $10,000 tax-free for use toward qualified education loans. Also, note that the $10,000 limit is per lifetime, but it can apply to more than one dependent. If a family has three kids with student loan debt, for example, they could withdraw $10,000 in tax-free funds for each child from their 529 plans for a total of $30,000.

Comment:  There are potential consequences of paying off student loan debt with 529 money.  One issue to recognize is that people who go this route may miss out on important tax deductions for student loan interest.  It is also possible that while paying off student loan debt is permissible for federal purposes, some states (while unlikely) could disallow a state income tax deduction taken upon funding the 529 plan or may try to apply a penalty to what they deem to be a non-qualified distribution.  Interest paid from the 529 for student loan debt isn’t tax-deductible under the student loan interest debt provisions.

All in all, whether to use 529 plans to pay down student loan debt will depend on factors such as a person’s tax situation, the interest rate one is paying on student loans and the opportunity cost of using the funds for something else.