Student loan debt has become one of the largest classes of consumer debt in the country. In fact, it affects as many as 45 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 2017 owing as much as $28,650 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, but it also helps them pay a portion of their student loans—or those of their beneficiaries—without facing any penalties.
- 529 plans are tax-advantaged savings plans originally designed to cover the costs of post-secondary education of the plan holder's beneficiary.
- The Tax Cuts and Jobs Act signed in 2017 expanded coverage to include qualified tuition expenses for K to 12 education.
- Under the SECURE Act of 2019, plan holders can use 529 plans to pay for tuition and qualified expenses of apprenticeship programs and can withdraw a lifetime maximum of $10,000 to pay down student loan debt.
The Basics of the 529 Plan
Created in the 1990s as a way to help people pay for the costs associated with post-secondary education, 529 plans are tax-advantaged savings plans. The plans let people grow savings for a beneficiary—a child, grandchild, or spouse. The plan also allows people to save for themselves.
There are two types of 529 plans—prepaid tuition plans and savings plans. Prepaid tuition plans give plan holders the ability to prepay tuition and other fees for the beneficiary, provided it is at a specified institution. Savings plans, on the other hand, resemble individual retirement accounts (IRAs) in that they are tax-advantaged plans.
Plan rules were laid out in Section 529 of the Internal Revenue Code (IRC). For instance, withdrawals from 529 plans were 100% free of federal taxes if they were used to cover qualified education expenses such as tuition and fees, or room and board.
In January 2017, House members Lynn Jenkins (R-Kan.) and Ron Kind (D-Wis.) introduced H.R. 529, also dubbed the 529 and ABLE Account Improvement Act of 2017. The bill was primarily designed to encourage employers to contribute funds to 529 plans on behalf of employees via a tax incentive. Up to $100 in employer contributions to these accounts were excluded from taxes. Small businesses that made 529 plan contributions also got a tax credit to help with the cost of setting up payroll deductions for these accounts.
The legislation also benefitted savers by removing penalties for using 529 funds to pay off student loans. Taxpayers who used 529 plan money for anything other than qualified education expenses were subject to a 10% federal tax penalty. Any distribution of earnings was considered taxable income, which could drive the saver's tax liability even higher.
The bill was considered a boon for families with leftover 529 plan money who want to avoid a tax penalty for making nonqualified distributions. The Internal Revenue Service (IRS) did allow accounts to be transferred from one beneficiary to another in the past, but if there are no other students in a family that can use the money, the account owner must either leave the fund unused or accept the tax liability.
Changes to 529 Plans
There have been several changes to the way plan holders can use 529 plans as of 2017 with the Tax Cuts and Jobs Act (TCJA), as well as with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019. Both laws were signed by President Donald Trump.
The TCJA changed the way 529 plans could be used, increasing some of their benefits. The primary change expanded coverage beyond post-secondary education to include a maximum of $10,000 in annual tuition expenses per student for K to 12 education at a public, private, or religious school. Other expenses do not qualify, and distributions made to cover any additional educational costs would be considered as gross income.
Additional changes were made to the plans after the U.S. House of Representatives passed the SECURE Act, which was signed on Dec. 20, 2019. Under Section 302 of the act, plan holders can now:
- Use their 529 accounts to cover expenses related to any registered apprenticeship program attended by the beneficiary. This includes any additional costs such as fees, equipment, books, and other supplies.
- Withdraw up to $10,000 from their plan to pay down qualified student loans penalty-free—with conditions. The first is that the $10,000 maximum is a lifetime limit for a beneficiary and each sibling. This means a family with two children can take out a maximum of $20,000 to pay down their student loans. Secondly, plan holders cannot claim any student loan interest deductions paid with this money.
The maximum lifetime limit a plan holder can withdraw from a 529 plan to pay down a beneficiary's qualified student loan.
The Bottom Line
Student loan debt remains one of the biggest kinds of consumer debt in the country. Although people with education debt have been limited to exploring existing avenues for managing their loans, there is a little relief. Since the passing of the SECURE Act, 529 plan holders are able to withdraw up to $10,000 tax-free to put toward their own student loan debt, or that of their children, grandchildren, or spouses. As with any other financial product, it's a good idea to check with your plan administrator for full details on how this works.