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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

Section 529 Plans & Student Loan Forgiveness

Section 529 plans have been for years now a popular way to save for future education expenses, especially to pay for college. What makes them so popular is the ability to invest funds held in a 529 plan account, have the income earned on the investments be tax deferred (like an IRA), and then if used to pay for qualified education expenses, such income will become tax-free. 

Further, many states, Arkansas being one, allow some amount of a 529 plan contribution to be deducted for state income tax purposes. 

One of the qualified uses of 529 plan funds is for the payment of student loans. The SECURE Act, which became law at the end of 2019, allows families to use a 529 plan to repay up to $10,000 in student loans owed by each of the plan beneficiary and the beneficiary's siblings. 

Federal student loan payments have been on pause for over two years as a Covid-19 relief measure, meaning even interest hasn't accumulated and collection efforts on past due amounts were put on hold. The pause was first put into place by then President Trump in March 2020 and has been extended several times by both he and current President Biden. The current deadline is September 1, 2022. 

It is rumored that President Biden is considering not just continuing the pause, but announcing broad-based actual loan forgiveness of at least $10,000 in debt and possibly more. As of this writing, that announcement has not been made, although it is speculated that it could come at any time. This would be in addition to other student loan forgiveness programs already in place, such as the Public Service Loan Forgiveness program, access to which was greatly expanded earlier this year. (Editor's Note: After submission of this article, the President did indeed institute a student loan debt forgiveness policy via Executive Order).

Some 529 account holders who were planning to use the account to pay student loans may be wondering now what effect student loan forgiveness measures may have on their plan accounts? Fortunately, there are options.

First, if additional student loan forgiveness indeed comes to pass, there likely will still be a loan balance owed on many students' accounts, short of legislation granting 100% forgiveness. One option, then, is to use the 529 funds to pay on the remaining loan balance, keeping in mind there is still a $10,000 lifetime limit on doing so.

Another option is to transfer the beneficiary designation to a relative whom you want to assist with college expenses (lucky them). The range of qualifying family members is pretty broad, including in-laws, cousins (and their spouses), and others. 

You could also simply hold on to the plan account for the use, say, of a grandchild later on. There is no required distribution beginning date, meaning the funds can be left in the account indefinitely. This makes for the potential of a nice legacy being left for future generations.

Or maybe you've been thinking about going back to school for more education yourself or even a degree. You can make yourself the account beneficiary and use the 529 plan funds to pay for your own expenses. Qualified expenses, by the way, include tuition and fees, books, supplies, equipment, and even room and board, if the student involved is enrolled at least half-time.

Lastly, if none of the above applies or is satisfactory to you, you can always just pull out the money and use it for other purposes. In that case, a tax hit will be taken on the earnings being withdrawn at the tax rate of the recipient, as you would with a traditional IRA for instance. On top of this, however, is imposed a 10% penalty, since the money wasn't used for qualifying expenses. 

Still, it's an option, and maybe one that's not so bad, if the account has been growing tax-deferred for years and years. You may still have more left over after taxes than if you had invested the same amount in a taxable account that you had to pay taxes on as you went, leaving less left over to stay working for you along the way.

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