Student loan debt impacts graduates long after they leave college. An analysis by the U.S. Department of Education found that undergraduate students are graduating with an average of $25,000 in student debt, according to a report by the White House. With cumulative student loan debt exceeding $1.6 trillion for more than 45 million borrowers, it’s reasonable to expect that many find it difficult to repay.

The IRS allows borrowers to use 529 plans to repay their student loans. At least one of these two tax-advantaged savings plans are available to borrowers throughout the country. Let’s look into 529 plans available, who qualifies for them, and if they can be used to pay for student loans.

Here’s everything you need to know about using a 529 plan to repay student loans:

What is a 529 plan?

A 529 plan is authorized by Section 529 of the Internal Revenue Code; though you’ll likely hear it referred to as a “qualified tuition plan.”. The purpose of a 529 plan is to save money for a beneficiary to pay for educational expenses separately from financial aid.

Two types of 529 plans exist: an educational savings plan and a prepaid tuition plan:

1. Prepaid tuition plan: This plan allows the plan owner (usually a parent) to help the beneficiary (usually a child) save for future tuition expenses by pre-purchasing credits or units from a postsecondary institution that participates in a prepaid tuition plan.

2. Education savings plan: This plan allows the plan owner to help the beneficiary save for future tuition or education expenses at elementary or secondary public, private, religious schools by opening an investment account.

A significant benefit to 529 plans is that withdrawals are tax free for student expenses, including tuition. The only way these withdrawals can be taxed is if the distribution amount exceeds the expense amount. In this instance, that extra portion of the distribution is taxable.

What are the differences between 529 plans?

Though both plans may be eligible in your state, you should be aware of the differences. For instance, some states only permit residents to open a prepaid tuition plan. The state may also have limits on when you can take out a prepaid tuition plan, depending on the beneficiary’s age or year in school. Account holders can also make diverse payments into these plans, such as lump sum, monthly, or yearly payments. 

A 529 savings plan is an investment through bond funds, mutual funds, or exchange-traded fund portfolios. These plans are similar to IRAs and 401(k)s: your total amount can fluctuate depending on how the stock market performs. There are two types of 529 savings plans: a direct-sold plan that you manage independently, and an advisor-sold plan which is managed by an investment firm. 

Regarding 529 fees and additional costs, prepaid tuition plans may have limited fees, such as requiring payment for non-tuition costs associated with college attendance. 529 savings plans may also have a variety of additional costs such as enrollment fees, annual maintenance fees, administrative or management fees, and underlying fund expenses. 

What is the SECURE Act? 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed in 2019 to change the rules to long-term retirement planning, as well as repeal certain taxes implemented by the Tax Cuts and Jobs Act. The changes are diverse and include impacts to how 529 plan funds can be used:

• Withdrawals are no longer taxed when using funds to repay qualified education loans
• A maximum of $10,000 per beneficiary can be put towards their loans
• Apprenticeship programs are now eligible for 529 plans
• Apprenticeship program expenses such as books and supplies are no longer taxed 

Can you use a 529 plan for student loans?

Yes, as of December 20, 2019, account holders can use as much as $10,000 from their 529 plan to repay their student loans. 

Not only can this maximum amount be withdrawn to pay the interest or principal on the beneficiary’s student loan, but it can also be used to pay off the beneficiary’s sibling’s student loans, too. That means that one account holder can withdraw up to $20,000 for their two children. 

Keep in mind that this is a one-time total distribution amount and that any interest paid is not eligible for student loan interest deduction.

Prior to 2019, account holders would have paid a 10% federal tax penalty for withdrawing 529 funds to pay for anything other than a qualified tuition expense. This change occurred when the SECURE Act was passed in 2019. The SECURE Act removed the withdrawal penalty and allowed for the repayment of student loans.

How to use a 529 plan for student loans

Before you decide to withdraw funds to put toward your beneficiary’s student loans, you need to check the rules for your specific state. Some states may not consider student loans as a qualifying expense. 

If you’re permitted to use these funds for student loan repayment, you’ll need to decide how much you want to withdraw. Keep in mind that, although you can provide a beneficiary with a maximum amount of $10,000, you’re also permitted to use these funds in other ways – including naming a new beneficiary to the account. Consider your current 529 balance, the loan balance of your current beneficiary, and if you think you or another beneficiary would benefit from access to these funds in the future. 

Uses for leftover 529 money

Although a person may invest in a 529 plan, their beneficiary isn’t required to use any or all of it. A beneficiary might not go to college or might have graduated without student loan debt. Regardless of the situation, leftover funds in a 529 account are still quite useful and there are a few options to consider.

As explained in the SECURE Act, leftover money can be put towards the beneficiary’s sibling’s student loans. The plan itself can also be transferred to a new beneficiary and the benefits will remain the same. 

Of course, if you’re willing to pay taxes on the remaining amount, all plan owners are allowed to withdraw the funds to use however they please. Keep in mind that it may make sense to leave funds untouched until after a bull market period to maximize its potential earning amount.

Consider refinancing to save money on your student loans

Even if you don’t have a 529 plan, you still have other options available to repay your student loans more affordably. One way is through refinancing. Refinancing your student loans means using a new loan to replace your current loan, often with more favorable interest rates or terms. 

For example, if you have $20,000 in federal student loans at a 6% interest rate, you can refinance them into a private student loan. The largest potential benefit is that you may pay less over the life of your loan with a lower interest rate.

Let’s consider a scenario in which you refinance your loans at a 4% interest rate for the same repayment term:

$20,000 in student loans over 10 years at a 6% interest rate involves a monthly payment of $222. Refinancing to a 4% interest rate at the same 10 year term drops your payment to $202 and saves you $2,346 if you pay this minimum payment until the term period ends. 

Refinancing has some drawbacks to consider. You aren’t guaranteed to get a lower interest rate or better terms. You’ll also lose all federal protections such as access to relief, repayment, or forgiveness programs if you refinance your federal student loans into private student loans. 

Use a student loan refinancing calculator and weigh your options to determine if refinancing is the most responsible financial decision for your specific student loan situation.