How on earth do student loans not count as a qualified higher education distribution form the 529?

[mcmillot15]

I'll try to makes this short and sweet. I graduated in May from an expensive and private college in Indiana. I am just now learning that my growing 529 balance will be absolutely useless in retiring my student loans. However, the 529 is great when one wants to retire tuition, books, room and board, etc while in school...What do you think makes up the student loans people??!! If one cannot afford to pay as they go through school, are they not supposed to even have a 529? Student loans do not count as a qualified distribution from the 529, but everything that has accumulated into that final four-year total debt number does?? How is this right?

Anyone else running into this problem. (also, for me to realize this money i will have to undergo a 10% penalty as well as a 3.3% income tax deduction from my 529 balance)

[dcandmc]

If one cannot afford to pay as they go through school, are they not supposed to even have a 529?

Simply put: no, it's expected that they will not have a 529. A 529 is for paying current qualified expenses, "current" in this context meaning within the same calendar year. If you graduated this past May, you possibly have qualified expenses that you paid earlier this year that can be reimbursed from your 529 THIS YEAR, even if those expenses were paid with loans. Take a distribution and pay off some of your loans, if you have qualified expenses that were paid this year. For qualified expenses that were paid in previous years, it's too late to use the 529 without taking the hit on taxes and the 10% penalty on the earnings part of any distribution.

Why is it that you have a "growing 529 balance" if you just graduated? This is not a normal situation, unless you are attending or planning to attend graduate school, and then of course you can use the 529 account for graduate school expenses. But most people who have a 529 begin funding it well before the beneficiary goes to college, and then spend the money down through the college years, so that any necessary loans are taken after the 529 has been exhausted.

[mcmillot15]

Thanks for the reply. It all boils down to me not realizing what the terms of the 529 were due to my assumption that student loans counted as a viable option. I wish I would have known that the qualified disbursements only counted within the year you took on debt for certain things pertaining to higher education. My account is growing because I never drew on it because this was my avenue for paying off the student loan payments coming in the near future. Obviously now the 529 balance is sort of sitting there with no real direction to go in. Should I just transfer the funds to my younger brothers in college or wait for the MBA to roll around?

[dcandmc]

It sounds like you had 529 money available to you while you were going through college, while at the same time you were taking out loans for college. If this is in fact the case, why would you do that? Why would you take out loans when you have a pot of money sitting there that is specifically designed to pay the same expenses for which you are borrowing? That makes no sense.

[chipper7]

Are your parents involved here at all? Do they own the 529 accounts? If so, could they transfer some of the money to your brothers account while giving you the money that they would have put into his 529 plan? There may be some gift limits, but it might be a way to at least get some of the loans balances paid.

Chip

[mcmillot15]

Dc:Not to throw my dad under the bus here but he was under control of the 529 while i was in college and I only started to manage it upon graduation. He assumed we could take out loans and then pay off the debt with 529 funds after four years. So that is why no funds were taken out at the initial college expense time frame. Had I known you had to use the funds while in college and at the time of the expenses, I would not be staring at all of this unused money.

[mcmillot15]

Chip: My dad was the one to open the account and it is still under his name. And as for your suggestion, that is what we are most likely going to do. My brothers will split my contribution and my parents will stop putting money into the 529 and start paying on the loan payments that are quickly approaching.

[Joseph_Hurley_SFC]

I wrote an editorial 14 years ago suggesting that the law be changed to include student loan repayments as qualified expenses. The treatment of 529 withdrawals was different then (taxed to the beneficiary as opposed to being tax-free) but I still think it would be a good idea. It would be fairly simple to craft language to prevent the same expenses from being counted twice.

Joe

[mark]

In theory I agree with being able to pay off student loans with 529 money. However, you are not required to use student loans in the same way you are required to use 529 funds. In fact, I believe you can do whatever you want with student loans. So this would be a way to use 529 money to pay for something it was not intended to be used.

[mcmillot15]

Joe: just read your article and I really hope that editorial has gained some momentum. I could not agree more with this:

" The nice thing about this change is that it would not require an amendment to the Higher Education Act, nor would it require a change of heart at the Education Department. All that is needed is a simple amendment to Code section 529 to add repayment of student loans to the list of qualified higher education expenses. Congress needs to make other "technical amendments" to the law in the wake of the 2001 EGTRRA changes, so why not add this one? The insertion of student loan repayments is made even easier by the fact that tax law already defines a "qualified education loan" under the provisions controlling the deduction for student loan
interest."

I was under the assumption that student loans WERE under the qualified higher education expenses. Is there a way to get behind this and start pushing for it in any way?

[mariaku]

1. There are no controls at all over how one spends student loan proceeds. One could legitimately decide to use the proceeds to pay for their vacation, their niece's wedding present or a new expensive puppy.

2. When one pays for their own tuition, whether with cash or with student loan proceeds (but NOT 529 proceeds), one qualifies for education credits based on these payments. For example, the first $2k of tuition paid with loan proceeds could give one a $2k of tax credit. So one could keep the $2k in cash while carrying the $2k of loan balance, even though effectively the entire cost of tuition has been reimbursed to them through taxes. Allowing the use of 529 proceeds to pay off this student loan balance would represent double-benefit for the same cost.

3. Finally, one is allowed to pay up to $10k of student loan balance (lifetime limit) with proceeds of 529 account.