529 Savings for Loans

Student loan borrowers may soon be able to pay down their debt using money from 529 savings accounts.

President Trump is expected to sign a spending bill that includes this provision Friday. The amendment would let those with 529 spending plans use the money toward expenses related to registered apprenticeship programs as well as qualified education loan repayments.

Currently, funds in 529 savings plans can be used toward expenses accrued from attending a qualified higher education institution, like tuition, housing or books. There are about 14 million accounts nationally with more than $350 billion in assets saved since 2009, according to the College Savings Plans Network. The average account in 2019 has about $25,000 saved.

This amendment limits the amount that can be used to pay off student loans to $10,000 in a person's lifetime.

It's unclear what the intent is behind the amendment, which is attached to legislation expanding and preserving retirement savings. The provision didn't grab many headlines until it was announced as part of the spending bill. These savings plans have been criticized in the past for mostly benefiting wealthier families, who use them for the tax benefits.

"If the goal is to help low-income students pay for college, this is not squarely targeted toward that goal," said Carrie Warick, director of policy and advocacy at the National College Access Network.

Under the bill, the savings accounts could be used by parents who have been saving for their children while paying off student loans of their own, recent graduates who didn't use 529s and now have student loans, or students who keep money in their 529s and take out loans for college to pay back later because it's a better investment, Warick said. All of the scenarios assume that people have the resources to put money into the account, and in some cases simultaneously make loan payments.

It could turn into another way for upper-middle-income and high-income earners to get tax benefits for paying off debt. For example, Jason Delisle, a resident fellow at the American Enterprise Institute, said he could now sign up for a 529 plan for himself to pay off a remaining student loan and get state tax deductions in the process.

​"You’re opening the thing up to gaming and gimmicks in a way that isn’t really what you’re intending to do, but I think that’s probably how this will be used," he said.

The amendment will likely affect states much more than the federal government, Delisle said. While the interest gained on 529 savings isn't taxed federally, each state adds its own benefits to the plan. For example, Virginians could get a tax deduction of $4,000 off of their taxable income if they invest in a 529 savings plan.

"Virginia may not have ever intended that I could use 529 distributions to pay off student loans and get a tax deduction, but Congress is going to make them eat that policy," he said.

The federal government is also a loan provider, so it's essentially giving people a state tax break to pay them back, Delisle said, adding that it lets Congress say they've done something about the student loan problem without burdening the federal government with the bulk of the cost.

While Delisle said he understands the change on a "practical level," because a loan is like an intermediary between a 529 plan and paying tuition up front, he agrees that it probably won't benefit those who need help the most.

"This does not seem, to me, a way to help someone who dropped out of community college, has some debt but doesn't have a degree, and is low to middle income," he said.

Using the savings plan also requires a high level of financial literacy, Warick said, which high earners are more likely to have, sometimes in the form of financial advisers.

The amendment didn't attract many headlines before today, and Warick said she doesn't know what its intent was. It's "wishful thinking" that it could help low-income families, she said, but it probably won't be very harmful because it's not likely to be a significant cost.

"The harm I would be concerned about here is the perception that this is helping low-income students and that Congress does not need to take far more drastic measures to help," she said. "This is not a substitute for much greater investment in our higher education system."

Delisle also doubts it will be a large cost, even to the states who will bear the brunt of its effects, unless it's widely adopted.

"My sense is that Congress is constantly hearing about people's anxieties about student debt, whether justified or not, so they are trying to do everything they can," he said. "So tucking things into a tax bill is one way to do it."