Author Topic: SECURE Act (allowing $10k of student loans to be paid from 529)  (Read 385 times)

Captain FIRE

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SECURE Act (allowing $10k of student loans to be paid from 529)
« on: January 17, 2020, 10:28:30 AM »
I understand that as of Dec. 19, 2019, the SECURE Act now allows for 529s to be used for paying student loans, up to $10k, and can be used by the beneficiary's siblings as well. 

I'm not a math person, so I'm trying to decide if it would make sense for us to pay my remaining graduate school loan with funds from our kid's 529.  Relevant factors:
- My loan is about $16k, at 2.5% interest.  Due to the low interest rate, we haven't paid it off and will let it ride even with this approach, withdrawing only ~$2k each year to pay the amounts due.
- Obviously, I can't use it for the entire amount, just up to the $10k limit permitted by law.
- Although it hasn't been open that long (kid1 is almost 3, other is still baking), we do have gains in it - just under 20%, although that's just a rough calculation and doesn't factor in that a good chunk of money was added at the very end of last year.
- To maximum the compounding growth of the tax-free benefit, we plan to max out the 529s every year until we feel we've funded them sufficiently to cover ~75% of a private college education, after factoring in compounding growth of 10-15 years.)  This means that effectively, we wouldn't be "replacing" any money we use for a few years (as it's money we'd be putting in anyways), which means less time for compounding on the "replacement" money.  This is largely why I wonder whether this is very worthwhile to do or more of a marginal gain.

Please do not turn this into a debate over how much to save in a 529 or whether we should send our kids to community college or let them fend entirely for themselves.  I know most Mustachians feel that way, however, we are hardcore believers in an excellent education.  While you may be able to get a decent education going a community college route, we think that's 1) a lot tougher to do/requires a lot more self-motivation, 2) even with effort, may not be the same caliber education*, and 3) doesn't offer the same networking experiences that seem so critical these days.

Questions:
- Does it save much money to do this?
- We'd need to switch the beneficiary to me, and then back again to the kid later.  Are there any issues with doing this? 
- If we do this, logistically, how does one actually go about withdrawing money to pay for it/reporting as such to the IRS?

*From personal experience, I found the education to be the best at the top 10 college I attended by a good margin, less so at the very good state school I took classes at during high school through an early admission program, and much less so at the community college I took classes at during high school.

mistymoney

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Re: SECURE Act (allowing $10k of student loans to be paid from 529)
« Reply #1 on: January 18, 2020, 08:19:17 AM »
Is the 529 money invested, and in what? at 2.5% I would be tempted to slow pay that and let the 529 money grow

secondcor521

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Re: SECURE Act (allowing $10k of student loans to be paid from 529)
« Reply #2 on: January 18, 2020, 10:27:31 AM »
Questions:
- Does it save much money to do this?
- We'd need to switch the beneficiary to me, and then back again to the kid later.  Are there any issues with doing this? 
- If we do this, logistically, how does one actually go about withdrawing money to pay for it/reporting as such to the IRS?

1.  No.  Imagine $1 in the 529 and $1 on your loan.

If you leave it in the 529 for one year, it (on average) grows to $1.10 - I'm assuming you've got it invested mostly in stocks because of the growth last year.  Your loan dollar costs you $1.025 - that's the 2.5% interest.  Subtracting the two means you gained $0.075, or seven and a half cents.

If you take it out of the 529, then you don't get the growth of the 10 cents, and you don't have to pay the 2.5 cents interest.  Since this math is just the opposite of the above, you've lost 7.5 cents.

You always want to adjust for risk and taxes.  There is risk that the 529 may not grow by 10% in any given year; it could even shrink.  The 2.5% is a guaranteed cost.  So the degree to which that risk concerns you or you think will happen, that leans towards paying off the loan.  Risk assessment is fairly personal, but it can be informed by education about the investments you're in and the history of those investments, and the underlying structure of why those investments might grow or shrink based on economic factors.

Taxes-wise, your 10% growth is tax deferred while in the 529 and tax free if withdrawn for qualified education expenses, which is very likely in your case, since you haven't yet overfunded the account and your partner is pregnant (congrats!).  That factor leans towards considering the 10% to be stronger than average because the taxes you're not paying over the years is equivalent to additional wealth for you.  The 2.5% might be tax deductible, depending on your income level, so that would make it a little lower on an adjusted basis.  So all this means that the difference is effectively more than 7.5 cents per dollar.

Since each dollar you take out via the SECURE Act option costs you 7.5 cents per dollar per year, most people wouldn't want to compound the pain by doing it with 10,000 of them.

2.  In my state quite easy - you just fill out a few forms.  In my sister's state, they won't let you establish a 529 for an individual over 18, so she couldn't do what you describe.  Call your 529 customer support and ask them.  Alternatively, you can open an empty account for you and then transfer funds back and forth from your kid1's account into your account.  It accomplishes effectively the same thing.

3.  To make a 529 withdrawal, you just contact your 529 customer support and say, I want to make a withdrawal.  It's not any harder than making a withdrawal from a bank savings account.  I actually can log onto my kids' 529 accounts and ACH the money into my checking or savings account via an online request.  Withdrawals made for qualified educational expenses are not reported on your tax return.  You and the IRS will receive a 529 from the 529 custodian each January reporting the amounts withdrawn over the previous year, and you should be prepared to prove that those amounts were spent on qualified educational expenses.  If they were not, then, well, it's reportable on your tax return (I *think* it's line 21 other income, but I'm not 100% certain and don't feel like looking it up right now - you could dig into Pub 970 if you're curious.)

Your 529 customer support might ask you if the withdrawal is qualified.  Since the SECURE Act is new, they may not have their systems set up to handle withdrawals that are qualified due to paying down student loans.