Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / Using 529 Plans for Student Loan Repayment
Transcript
- Lucas: A lot of parents pour money into a 529 plan hoping their kid won't need student loans. But what if they do? There's actually a way to use those same 529 dollars to pay down the debt after graduation. Luna: I've heard there's a $10,000 limit or something. Is that the SECURE 2.0 provision? Lucas: Exactly. Starting in 2024, the SECURE 2.0 Act allows 529 plan owners to withdraw up to ten thousand dollars per beneficiary — that's a lifetime limit, not annual — to repay student loans. And the withdrawal is still tax-free for federal income tax purposes, just like using the money for tuition. Luna: So who qualifies? Does it have to be the original beneficiary, or can it be a sibling? Lucas: Good question. The withdrawal must be for loans taken out by the beneficiary — the person named on the 529 account. But you can always change the beneficiary to another family member, as long as it's an eligible family member under the rules. So if you have one child who doesn't need loans and another who does, you could reassign the account. Luna: And the loan has to be a qualified student loan, right? Like federal direct loans or private loans for higher education? Lucas: Correct. It applies to any loan that qualifies under the student loan interest deduction rules in the tax code. That means federal and private loans used for tuition, fees, room and board, books — at an eligible institution. Parent PLUS loans taken out by the parent also qualify, as long as the withdrawal is for the beneficiary's loan. Luna: So if a parent borrows with a Parent PLUS loan for their child's education, they can use the child's 529 to pay it? That seems backwards. Lucas: It does, but the IRS treats the Parent PLUS loan as a loan for the student's benefit. So yes, a withdrawal from the student's 529 can pay off a Parent PLUS loan, up to that ten thousand dollar lifetime cap per beneficiary. It's one of those head-scratchers, but it's in the rules. Luna: Okay, so the cap is per beneficiary, not per account. So if you have twins and they both have loans, you could do ten thousand each. Lucas: Right. But here's a nuance: the ten thousand dollar limit is per beneficiary across all 529 accounts. So if Sarah has a 529 from you and a separate one from her grandparents, combined withdrawals for her loans can't exceed ten thousand dollars. And withdrawals for loan repayment also count against the overall qualified education expenses bucket — they don't stack on top of other categories. Luna: That's important. So you can't do ten thousand in loans plus another ten thousand for a computer and call it all tax-free. It's all part of the same tax-free distribution limit. But there's no separate penalty if you exceed qualified expenses — just taxes and the 10% penalty on earnings. Lucas: Exactly. And you need to keep good records. The IRS expects you to track the loan statements and show that the withdrawal didn't exceed the actual loan proceeds. Also, you can't double-dip: you can't claim the student loan interest deduction on your taxes for the same interest that was paid with 529 funds. Luna: Right, because that would be tax-free money paying the interest. So it's either or. For a lot of families, the 529 withdrawal makes more sense if they're in a higher tax bracket where the interest deduction is phased out anyway. Lucas: Exactly. The student loan interest deduction phases out for single filers above about $90,000 of modified adjusted gross income and joint filers above $185,000. So if you're in that phase-out range, using 529 funds might be a no-brainer. But even if you're below those thresholds, the deduction maxes out at $2,500 of interest — so a $10,000 withdrawal paying principal could be more valuable. Luna: Let's talk strategy. Is it ever a good idea to intentionally underfund college and use the 529 later for loans? That seems backwards compared to the traditional save now pay tuition then approach. Lucas: It could make sense in a few scenarios. One is if you're uncertain about your child's path — maybe they might not go to college, or they might get a full scholarship. If you know the 529 might not be fully used for tuition, using it for loans provides a backup. Another is if you have a late start saving; you might want to keep the 529 invested during college and let it grow, then after graduation use some of the gains to pay down loans tax-free. Luna: But the 10,000 limit isn't huge. Average student debt in the US is around thirty thousand. So it only covers a third of that. Lucas: Right, it's modest. But it's one more tool in the box. And remember, you can also use the 529 for the beneficiary's graduate school expenses — so if they go to law school or medical school, those costs can be enormous. The loan repayment provision is specifically for loans from any qualified education, not just undergrad. So if your child takes out loans for graduate school later, that 10,000 can help there too. Luna: One thing I want to clarify: the withdrawal must be made in the same calendar year as the loan repayment? Or can you withdraw after the fact? Lucas: The IRS hasn't given super specific guidance, but the general rule is that the distribution should be used for qualified expenses in the same year. So ideally, you withdraw from the 529 and then pay the loan in the same year. But you could also pay the loan with other funds and reimburse yourself from the 529 in the same year. Just keep clear records. Luna: Practical. So what about gift tax? If grandparents own the 529 and they use it to pay their grandchild's loans, does that count as a gift? Lucas: Yes, it's still considered a gift from the account owner to the beneficiary. But you can use the annual gift tax exclusion — $18,000 per person in 2026, or $36,000 if married filing jointly — to shelter it. And there's a special election for 529 plans to average contributions over five years. But just be aware that the gift is based on the withdrawal amount, not the original contribution. Luna: Good to know. So let's say I'm a parent looking at this. What's the first step I should take if I'm interested? Lucas: First, check if your state conforms to the federal treatment of loan repayment as a qualified expense. Some states automatically follow federal law, but others — like California, for example — haven't passed enabling legislation. If your state doesn't recognize it, the withdrawal might be tax-free federally but subject to state income tax. Second, look at your current 529 plan's withdrawal system. Many plans have updated their forms to include a reason code for student loan repayment. Luna: And I'd add: talk to your tax advisor. There are some knotty issues around coordinating with the student loan interest deduction and possible 'adjusted qualified education expenses' if the student also got tax-free scholarships. Lucas: Absolutely. But the bottom line is: this provision gives families more flexibility. For years, people worried about overfunding a 529 and facing penalties. Now they have an extra safety valve — even if it's limited to ten grand. Speaking of which, I want to mention something quickly. Luna: Sure, go ahead. Lucas: We keep the podcast free and ad-free because a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo. That money literally funds the research and recording time. If these episodes have helped you make a smarter savings decision, that's the reason we do it — and the support keeps it going. Luna: Yeah, it's a small crew, but every contribution matters. We're grateful for those who do. Lucas: Alright, back to the loan repayment angle — one more thing to watch for: if your child qualifies for Public Service Loan Forgiveness, you might not want to use 529 funds to pay down those loans early, because they could be forgiven anyway. Better to keep the 529 for other expenses or even the Roth rollover if the timing works. Luna: That's a good point. Prioritize loans that won't be forgiven. Also, if the 529 account is relatively new — less than 15 years old — the Roth rollover isn't available. So loan repayment might be the best use for leftover funds. Lucas: Exactly. And let's not forget: the 10,000 limit is per beneficiary, but if you have multiple 529 accounts for the same beneficiary, you need to coordinate. One final thought: the provision is set to expire after 2025 unless Congress extends it. As of July 2026, it's still in effect, but who knows what future tax bills will bring. Luna: So take advantage while you can. A lot of families are sitting on 529 funds wondering what to do if their kid graduates without needing all of it. This is a valid use that Congress intentionally created. Lucas: Right. And if you're already making loan payments, you could even take a 529 distribution now, reimburse yourself for payments you made earlier in the year, and reduce your outstanding principal. Just keep the documentation. Luna: That's a smart year-end strategy. Alright, I think we've covered the essentials. Any final takeaway? Lucas: Only this: a 529 plan isn't just for tuition. It's a flexible savings tool that now extends into the borrowing years. The SECURE 2.0 provision adds student loan repayment to your options, giving you one more way to ease the burden on your graduate. Luna: And that's something worth planning for now, even if college is years away. Thanks, Lucas. Lucas: Thanks, Luna. And thanks to everyone who listens. See you next time.