Some student loan holders can tap 529 plan funds as payments restart

Thanks to a law passed four years ago, borrowers with outstanding federal student debt are able to tap into any remaining 529 college savings plan funds they have to pay down up to $10,000 of what they owe.

That may now be a particularly appealing option, given that federal student loan bills are set to resume in October.

The investment accounts, which are named after Section 529 of the Internal Revenue Code, are offered through states to encourage people to save for college. Withdrawals put toward qualifying education expenses are tax-free.

Under the student loan provision, which became law in 2019, those who have a 529 account can use it to cover the principal and interest on their education debt. In certain cases, the accounts can also be switched to family members with student debt, too.

“There are several situations in which this capability is worthwhile,” said higher education expert Mark Kantrowitz.

The reality is, of course, that most college students who graduate with student debt won’t actually have money remaining in their college savings plan, experts point out. (If they did, they wouldn’t have needed to borrow in the first place.)

However, it’s possible a college graduate with student debt has a sibling with remaining funds in their 529 plan, Kantrowitz said.

“Perhaps they went to a lower-cost college or won a scholarship,” he said. In such cases, they may be able to change the account’s beneficiary and use their sibling’s plan to pay off some or all of their debt.

The lifetime limit of the option is $10,000.

Meanwhile, if the beneficiary of a 529 plan is changed from the student to a parent, Kantrowitz said, the parent might be able to pay off their Parent Plus loans with the investment funds.

Before parents or college graduates withdraw from a 529 plan to pay down student debt, they should compare the interest rate they’re paying on their loans with the earnings they’re picking up in their investment account, experts say. They could be earning more in the market.

“But, there’s something to be said for simplifying one’s finances and the freedom that comes with having paid off debt,” Kantrowitz said.

The investment accounts can be used to pay for all federal student loans, and most private student loans also qualify, said Elaine Rubin, director of corporate communications at Edvisors.

Although borrowers won’t be dinged with federal taxes on their eligible 529 withdrawal, they may face state taxes, Rubin added.