Not your Grandparents’ 529
On August 24th, 2022, President Biden announced his Student Loan Forgiveness Plan which has been long awaited by many strapped with thousands in student loan debt. Applications for borrowers to fill out are now live, and as of November 3rd, twenty-six million have applied.¹ There are still legal hurdles that need to be cleared for the forgiveness to actually take place. But, with all of the news on student loans, this is a great opportunity to discuss utilizing a 529 plan to help pay off that remaining balance.
In short, a 529 is a tax-advantaged plan designed to help pay for education. 529 Plans grow tax-deferred, and withdrawals are tax-free if they are used for qualified educational expenses. With the passing of the Secure Act in late 2019, 529 Plans now have the ability to pay up to $10,000 of student loan debt over the lifetime of the plan. That means not only can the plans be used in the traditional sense of tax-free distributions for higher education, but they can also be used to pay up to $10,000 of student loan debt.
Like many of our fellow millennials, the college years are already behind us; our generation is strapped with student loan debt and repayments month to month set to resume in January of 2023. The Secure Act Change in 2019 provides an opportunity for anyone who has student loan debt to make 529 contributions while getting the state income tax deduction and then make payments from the 529 on your student loans. For example, you can make a $10,000 contribution to a 529 with yourself as the beneficiary. You would receive a State of Michigan income tax deduction of $10,000 which would save you approximately $425 in taxes. You can then make the payment from your 529 to your student loans. With this strategy, the objective is not to get tax-free distributions on the growth but to receive the state income tax deduction on the contribution. The only rule is that you have to make the contribution in one tax year and the distribution in another year to receive the tax deduction. You fulfill this requirement by making the contribution in December and doing the distribution in January of the following year.
Have you been saving up during deferment to dump a lump sum on your remaining student loans once repayment starts? If so, this is certainly an effective strategy that can be utilized to shelter income from state tax for making the same payment you would have made anyway.
Written by Kyle Cooper
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