Can You Use A 529 Plan To Pay Off Your Student Loans?

Setting money aside early for your child's college is a smart decision and radically minimizes the total contribution you have to fund directly when the time comes to start paying for school expenses. Pundits across the spectrum, including Jim Cramer, offer their two cents on this issue and universally agree that the 529 plan (which has no federal cap on contributions) is a major game changer for parents planning ahead for their young ones' futures.

But, saving for college doesn't generally focus on what to do with leftover money after everything's been accounted for. Moreover, collegiate studies aren't going to be part of everyone's life plan. As for those who do pursue postsecondary education, they may end up using plenty of student loans while in school.

In this latter scenario, your 529 plan might make more sense as a payment option when servicing student debt after leaving school rather than as a direct means of payment while in school. Indeed, a 529 plan, because of the SECURE Act of 2019, can now be leveraged to pay off student loans instead of acting as a primary payment method (or in tandem). Here's how this might work for a typical student borrower.

Up until recently, 529 plans were limited in their disbursement options. The SECURE Act of 2019 changed this, adding a potent alternative for students with loan debt. In addition to being a payment vehicle for funding a beneficiary's education, money invested in a 529 plan can now be used to pay off student loans.

The SECURE Act allows a beneficiary to now pay down as much as $10,000 in student loans from a 529 plan. The legislation also makes clear that an account beneficiary can also pay off up to $10,000 in loans for each of their siblings; this doesn't mean you can double dip, however. The cap appears to be worded not as a withdrawal limit from a 529 plan, but as a max payoff figure derived from 529 plan funds. This eliminates any designs you might have on paying off $10,000 for yourself and then trading equal payments with a sibling out of remaining 529 plan funds to add more to the top.

A smart saver will notice that 529 plans don't exhibit a mandated draw period. The funds don't have to start coming out of the account as soon as you, as the plan's beneficiary, begin college, nor are they mandated to be used at any other point in your academic career, including after it's concluded. What this means is the 529 capital can remain right where it is while you're in school, accumulating more years of compound-interest growth (check out 12 of the best compound interest investments ranked).

At the same time, taking out student loans, which don't demand monthly payments, while you're actively engaged in at least half-time learning, and then repaying them with your 529 plan funds can dramatically alter your personal financial landscape. For instance, it's well known that mildly aggressive growth investments tend to double roughly every seven years. With the six-month grace period after graduation included in your educational timeline, a standard four-year degree followed by a two-year graduate course of study leaves your 529 savings account just six months shy of an extra doubling event that may take place between your first day in school and your last, given the opportunity.

With twice as much capital in your 529's coffers, paying off a chunk of your student loans with it (max $10,000), then letting your parent(s) utilize the plan's remaining funds elsewhere (perhaps even naming your child as the new beneficiary in the future) might revolutionize your financial future.

The SECURE Act 2.0 of 2022, signed into law on December 29, 2022, allows account owners to shift unused funds from a 529 plan into a Roth IRA for the beneficiary, giving them a head start with their retirement savings. That is, you can now move money — up to $35,000 — from a college savings account into a Roth for the designated beneficiary, with yearly limits remaining in place. In 2024, for example, the annual contribution limit for an IRA is $7,000 for anyone 50 years old or younger, so it would take up to five years at least to roll over the maximum $35,000.

Another rollover stipulation is that the 529 account must have been open for at least 15 years. Also, the beneficiary must have earned at least as much as the rollover amount for that year. Alternatively, if the 529 plan's original designated beneficiary opts not to attend college or doesn't need the entirety of the funds saved for their education, the 529 plan's account owner can change the beneficiary. As said, perhaps you might request that it change from you to your child. Account owners can designate a different beneficiary without tax consequence so long as the new beneficiary is a qualified family member of the current beneficiary.