How to use your 529 plan to pay off student loans

A 529 saving plan is well-known for its ability to help parents and students deal with the cost of education. While it was originally set up as a way to pay for the spiraling costs of college, the 529 has been expanded to include K-12 education, trade schools and other qualified programs. In addition, a 529 plan can be used to pay off student loan debt, thanks to 2019’s SECURE Act.

Here’s how you can use a 529 plan to pay off student loans and some smart ways to do so.

How a 529 plan can help you pay down debt

The SECURE Act of 2019 helped expand the flexibility of 529 accounts, especially when it comes to using the money to pay down the costs of college after a student has graduated.

The act allows the beneficiary of a 529 account to pay off up to a lifetime limit of $10,000 in student loans. The money can be withdrawn and paid to the lender, extinguishing the debt. The act also permits a 529 to pay up to $10,000 in student loans for each of a beneficiary’s siblings.

So the act massively expanded the 529’s ability to pay down college costs even after the fact.

But don’t think you’ll be able to double- or triple-dip on these benefits, says Delvin Joyce, certified financial planner and certified financial advisor for Prudential. Some individuals may think that they can use that $10,000 benefit multiple times if they have multiple 529 plans and siblings to spread it around. But no – you’re capped at a lifetime total of $10,000.

And unlike the strict rules governing a 529 plan – such as ensuring that your withdrawals come out only in the calendar year you’re using the money – it’s hard to go wrong here.

“There’s really no way to screw it up as long as you have extra 529 funds and student loans,” says Joyce.

2 more ways to get even more from your 529 plan

Those looking to maximize the benefits of their 529 plan have a few more ways to do so smartly, however, making the plan an even better pick for education expenses.

Joyce explains how to use student loans to give your 529 extra time to compound.

“If you can access subsidized student loans – loans that don’t accrue interest until after you’ve graduated – then it can make sense to take subsidized loans and then let your 529 plan grow over time during college,” says Joyce.

Then when you graduate, you can pay off the loan with your potentially greater 529 balance. In effect, you’re getting an interest-free loan to grow your 529 investments for four or five years, or potentially longer if you move directly to graduate school after earning a bachelor’s degree.

This approach can also help if you’re dealing with the restrictions on 529 plans, which do not allow you to pay for some relevant costs of attending school such as transportation.

“Incidental costs are not covered by 529 plans,” says Joyce. “It’s an ideal time to take a subsidized student loan and then use the 529 plan later to pay it off.”

And don’t think that because you set up a 529 plan for a specific child or beneficiary that it’s stuck there. You can switch the beneficiary – even to yourself – and pay down student loans.

“For example, if you’re a parent paying into a 529 plan and then the child gets a scholarship, you can change the beneficiary to yourself and then pay off your own student loan,” says Joyce.

SECURE Act 2.0 helps you pay down debt while saving

But things have gotten even a bit better for those using 529 plans, thanks to 2022’s SECURE Act 2.0. You can convert funds in the account to a Roth IRA, starting in 2024. The act also made it easier for those with student loans to save for retirement while paying down their debt.

Perhaps the biggest benefit of SECURE Act 2.0 for 529 plans is that they can be converted to a Roth IRA, a tax-free retirement account. The conversion is subject to certain conditions:

• You’re limited to a $35,000 lifetime conversion limit.
• Conversions in any tax year are limited to that year’s IRA contribution limit.
• The 529 account must have been open for at least 15 years before a conversion.
• Any money converted to a Roth IRA cannot exceed contributions and earnings on them in the five years prior to the conversion date.
• The owner of the Roth IRA must be the same as the 529 plan’s beneficiary.

After being used to pay down debt, any leftover 529 money could then help kickstart a child’s retirement funding, helping give them decades of compounding before they’d need to access the money. Here’s how to convert a 529 plan to a Roth IRA and what to watch out for.

The SECURE ACT 2.0 also helps those with student loans and who may be forgoing saving for retirement because of them.

“The wonderful change with SECURE Act 2.0 is that it allows your employer to treat your student loan as a contribution to a retirement account and then provide a match,” says Joyce.

In effect, when an employee pays down a student loan, the employer is allowed to match it with what they’re contributing as an employer match to their retirement plans such as a 401(k). That allows and incentivizes new graduates to pay down their loans without sacrificing savings.

This new feature doesn’t kick in until 2024, but it’s one of the most welcome changes and should help those with student loans save for the future while still paying off their debts.

Bottom line

A 529 plan can now do much more than it could even a few years ago, thanks to various changes in laws, and the plan can now help pay down student loans. But those willing to engage in some smart planning can set up their 529 plans to pay off even more.