Looking closely at fine print on new law

529s and the Secure Act of 2019

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Editor’s Note: The following article was written by Accredited Financial Counselor Todd Christensen. Any opinions expressed in this article are those of Mr. Christensen.

If you were enjoying your 2019 end of year holidays (meaning, you were not watching the news or following politics), you likely missed the signing into law on December 20, 2019, of the SECURE Act. While the law mainly focuses on retirement planning issues, it also makes a potentially significant change to the world of student loan repayment options.

How does the Secure Act of 2019 change student loan repayment?

Section 302 of the Secure Act of 2019 permits the distribution of funds from college savings 529 accounts for registered apprenticeship programs. Additionally, you may use past or future 529 contributions to repay up to $10,000 toward your existing qualified student loan(s). States will need to make changes to their 529 programs in order to finalize this possibility.

That’s a big deal if you have student loan debt, especially if you have never used a 529 plan for your college expenses before. Setting up and using a 529 plan to make current or future student loan payments means you can dramatically cut your federal and, most likely, state taxes.

529 Plans and Their Benefits

A 529 college savings plan is an investment account that provides various tax benefits when funds are used for education-related activities. These accounts originated in 1996 through Section 529 of the Internal Revenue Code. Contributions to a 529 plan are not reported on federal tax returns, even though earnings in the 529 account will not be taxed when withdrawn (similar to a Roth IRA).

While some states do not offer tax benefits through their 529 plans, most consider 529 contributions to be tax deductions, meaning you will not need to pay state tax on the full amount contributed.

Flexibility of 529 Plans

Over time, the uses of a 529 plan distribution have greatly expanded. Where originally 529 funds could be used for tuition and fees, they can now be used for any books, supplies, and even equipment required by the educational program, course, or school.

How Long Funds Need to Remain in a 529 Plan before Using Them

While you can leave your contributions in a 529 plan for decades, even transferring them to other family members, they must only remain in your 529 account for 7 to 10 days to qualify for the tax deduction benefits offered by most states. You are reading that right. You can contribute $100, $500, or $10,000 to your 529 plan, leave it there for less than two weeks, and then take it as a distribution for qualified educational purposes and still receive all the tax deduction benefits most states offer.

Changes to 529 Plans as of 2020

The SECURE Act signed into law in December 2019 and in effect as of 2020, added the following new sections to IRC 529:

Section 302(a): Distributions For Certain Expenses Associated With Registered Apprenticeship Programs

If you are currently in a registered apprenticeship program or plan to be in one in the future, you may now use distributions from a 529 plan for associated expenses, as outlined above under the plans’ flexibility.

Section 302(b): Distributions For Qualified Education Loan Repayments

This is the big one for the 40+ million Americans who already have student loan debt. So long as that student loan debt was “incurred by the taxpayer solely to pay qualified higher-education expenses” (required tuition, fees, books, supplies, and equipment), you can now use funds for your 529 plan to pay up to $10,000 of your existing student loan debt if it is considered a “qualified educational loan.”

“Qualified educational loans,” according to US code 26 is any indebtedness incurred by the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent to pay for qualified educational expenses.

This $10,000 is a lifetime limit, not an annual limit, so you cannot use it to repay debts greater than $10,000.

Qualified Loans

To take advantage of this opportunity to receive state tax deductions for repaying a student loan, you must have an eligible student loan now or in the future. Qualified student loans are any indebtedness you, your spouse, or your dependents have incurred for qualified educational expenses at eligible private, public, or religious colleges and universities.

Additionally, the 2017 Tax Cuts and Job Act lets you use 529 funds for qualified educational expenses at private religious and private charter elementary and secondary schools, from kindergarten through 12th grade.

Possibilities

There are various ways you can take advantage of this new change.

  • Consider the implications of these changes if you already have student loan debt from your time on campus, whether it was five, fifteen, or even twenty years ago. Let’s assume your loan balance is sitting around $40,000 (pretty typical for a newly-graduated bachelor’s student). That would place your monthly payment around $460, and we will make it due on the 25th of each month.

You deposit the $460 payment to your 529 plan on the 10th of the month, giving it a few business days to process. You let the money sit in your 529 plan for the qualifying 7 to 10 days. You make the payment to the lender on the 25th in whatever form you choose (check, money order, online payment, etc.). Then you request the $460 reimbursement from your 529 plan on the same day. For a $460 student loan payment in a state with a 6% income tax rate, you just saved yourself nearly $330 in taxes for the year. If that doesn’t seem like much, consider that it is almost three-quarters of your next monthly payment.

  • If you took out a loan to pay for your child’s private elementary or secondary education, you may now use a 529 plan to pay down that debt.
  • Funds in your 529 plan may also be used by your spouse or dependents to repay their eligible educational expenses or debts. You will need to make sure the account lists them as the beneficiary.

There’s Always a Caveat

As with most laws, the SECURE Act also has a catch. It is a federal law and makes changes to federal statutes. These include the benefit of not having to pay federal taxes on any earnings from your 529 plan.

To take advantage of the state-level benefits these possibilities include, contact your state’s 529 plan office to ensure the federal changes are effective on the state level. It may help to know that many states contract their plan management to brokers that are out of state. In such cases, you may be told by phone customer service you will have to contact your local level plan. Call your state’s treasurer to get in touch with the right contact to answer your question locally.

Some states are already promoting the changes. Others may be figuring out how (or even if) there are changes they need to make to their programs.

Word of Warning

When requesting reimbursement, be sure to do so in the same calendar year during which the educational expense or loan payment occurred. If you make a loan payment on December 28, you will have to hurry to request the reimbursement before January 1 of the following year.

This also means that you cannot contribute money into your 529 account to reimburse yourself for a loan that has already been repaid in the past. That said, the new paragraph (c) makes these changes retroactive from January 1, 2019. Talk to your state’s 529 plan administrator or a CPA specializing in 529 plans for individual advice.

Setting up a 529 Plan

What if you do not have a 529 plan yet, but you do have eligible student loan debts to repay? Is it too late? No.

529 Plans are sponsored by the treasurer’s office in each state. You can find links to your state 529 plan through the 529 College Savings Plans site affiliated with the National Association of State Treasurers.

When setting up a 529 account, you will be required to provide your standard personal information (name, social security, date of birth, etc.), the name and personal information of the account’s beneficiary (whoever in your family will be using the funds), and a deposit. Most 529s require just $25 to open an account.

You will also need to identify your preferred type of portfolio. For example, if you are setting up a 529 account for your newborn baby who will not use the funds for a decade or more, you may consider opting for an aggressive portfolio that has the chance to earn significant returns. If, on the other hand, you expect to use the funds within the year, you will probably want the most conservative portfolio to minimize your risk of loss.

After all, most funds in your 529 plan are not insured by the FDIC. That said, several states do offer investment options that include high-yield savings and certificates of deposit insured by the FDIC. If you plan to use your 529 account basically as a pass-through for your student loan payments, such a secure portfolio will likely meet your priorities.

How to Contribute to a 529 Plan

Once you have set up your 529 account, you can make one-time contributions either online or by mail. You may also set up recurring contributions from your savings account, your checking account, or even as a direct deposit from your paycheck, if offered by your employer.

Ineligible Loans

Not surprisingly, you may not use 529 funds to pay down or pay off a personal loan, loans from family or relations, loans under qualified employer plans – such as 401Ks or 403Bs – or employer loans.

Additionally, loans taken on after graduation (e.g., refinancing a student loan with a personal loan) and loans from ineligible educational institutions may not be reimbursable from your 529 account. If you are unsure of your school’s acceptability for this option, find eligible educational institutions at the Department of Education’s Federal School Code Search.

Disclaimer

For questions related to your individual circumstances, contact a CPA, or get in touch directly with your state’s 529 plan.

About the Author

Todd Christensen is author of Everyday Money for Everyday People and the education manager at Money Fit by DRS, a nationwide nonprofit credit counseling agency based in Boise, Idaho where he teaches people how to budget, pay down credit card debts, and control consumer spending.